Roth vs. Traditional Retirement Accounts? A Practical Guide for Savers

Roth vs. Traditional IRAs: The Core Tradeoff
Clients and friends often ask whether Roth or Traditional options are better for their retirement accounts. The easy answer is, to the dismay of many, “it depends.” What does it depend on? In short, taxes. Chiefly, when will you be taxed and at what rate?

A Traditional retirement account (be it 401k or IRA) provides a tax deduction. By saving, or contributing, to your retirement accounts will actually reduce your taxable income for the year. Reducing your taxable income now “pushes,” or delays the tax burden down the line, when funds are withdrawn from a Traditional account. These withdrawals will be taxed as “earned income,” meaning you will pay your regular income rates, akin to the tax bracket you’re in, on Traditional withdraws as if they are a part of your salary or wages.

Conversely, a Roth retirement account does not provide a deduction to your taxable income. Roth accounts are funded with post-tax dollars, meaning you bear the tax burden up-front. In exchange, qualified withdrawals are completely tax-free. Keep in mind that there are income limitations that may reduce, or even eliminate, your ability to contribute to a Roth IRA. This same limitation does not apply to Roth workplace retirement accounts, and the limitation can be circumvented with “backdoor Roth conversions.”

For more on backdoor Roth conversions, here is a blog post from one of our advisors, Matt Costa.

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What Happens If I Don’t Make Withdrawals?
Another key difference between Traditional and Roth accounts is what happens if the funds are not drawn in retirement. Traditional retirement accounts require you to start taking money out in your early 70s. These withdrawals are called “required minimum distributions” (RMDs). The amount you must take out is determined by your prior year balance and an IRS life-expectancy table. So, it is not static and will rise or fall as markets change and as you age. Skipping a required withdrawal comes with heavy consequences: the IRS can assess a 25% excise tax on the shortfall. As always, it pays to plan ahead.

Roth accounts are different. There are no required withdrawals for the original owner, which allows the account to keep growing tax-free indefinitely. If the differences are still confusing, let’s take a look at the example below:

A Simple Side-by-Side Example
Assume you invest $100,000, it triples over time, and you have the same tax rate (25%) currently that you will have in retirement.

• Traditional (pre-tax): $100,000 first grows to $300,000. Then you pay 25% tax on withdrawing from the IRA. Leaving you with $225,000 after taxes.
• Roth (post-tax): Instead, pay 25% tax bill up front, leaving only $75,000 to invest. That triples to $225,000, and you can withdraw it tax-free.

Surprisingly, both scenarios yield the same after-tax amount of $225,000. This is certainly an oversimplification and unlikely scenario, mainly because a static tax rate is unlikely. More on the nuances below.

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When Roth Accounts Makes Sense
If you are early in your career, a Roth will often be the correct fit. That’s because your income is low, relatively speaking. You’re likely in a smaller tax bracket when compared to the tax rate you’d expect later in your career (this is assuming your income increases and that the effective tax rate will also rise). Under these conditions, paying tax now will ensure that qualified withdraws from your Roth retirement accounts are tax-free (when you may be in a higher tax bracket). This reduces your lifetime tax burden and provides flexibility later.

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When a Traditional Account Makes Sense, Plus the Early-Retirement Window
Making Traditional contributions to your 401k is preferable during your high-income years because the deduction will shield your income from its current, highest rate. You accept that the later withdrawals will be taxed as earned income, because the up-front savings reduce what will end up as your highest tax bills, kicking the obligation down the road until retirement, when you’re (likely) in a much lower tax bracket.

Traditional IRAs have an additional rule that calls for a different strategy. There is a “phase-out” threshold that measures your income. If the top-end of the threshold range is exceeded (for single filers in 2025 this will be $89,000), then your retirement contributions may not cause a deduction to taxable income. Make sure you research your tax bracket to know the ways retirement contributions will impact you.

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Turning Traditional into Roth: A Practical Guide to Roth Conversions
Roth conversions are a strategy for tax efficiency when making distributions from your Traditional IRAs, causing a larger taxable income burden.

Often there is a window of time after you retire and before you start collecting Social Security where you may have little-to-no taxable income. A Roth Conversion is when you withdraw large amounts from a Traditional IRA, raising your taxable income during the lowest-tax bracket years of your adult life, and transferring that money to a Roth IRA. Once in a Roth, it can continue to grow tax-free. In the meantime, you’ve saved yourself from a higher tax bill once Social Security and RMDs kick in.

For more on Roth conversions, here is an additional article from our custodian, Charles Scwab.

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Basic Scenarios to Consider

• If you expect a higher tax rate later, lean Roth.
• If you expect a lower tax rate later, lean Traditional.
• If uncertainty is high, split the contribution and reassess next year with fresh numbers.
• If you opt for pre-tax, plan for potential Roth conversions during the low-income years of early retirement for maximum efficiency.

If you are still unsure which option fits you best, contact us or speak with a local fiduciary advisor. A brief conversation can help you choose the right path and set yourself up to be comfortable in your twilight years.

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