Traditional vs. Roth

Why this matters

When you open an IRA, or if your workplace plan offers a Roth option, you face the same question: traditional or Roth? The choice decides whether you pay tax on this money now or later, and it can make a real difference over decades. It's simpler than it looks, because it mostly comes down to one comparison.

The same money, taxed at different times

In a traditional account, contributions go in before income tax and withdrawals are taxed. In a Roth account, contributions are made with money that's already been taxed, and qualified withdrawals, including the growth, are tax-free.¹ To compare them fairly, start with the same slice of your pay:

• Traditional: $1,000 of pay goes in whole. It grows, and you pay tax on everything when you take it out.
• Roth: you pay tax on the $1,000 first. At a 22% rate, $780 goes in. It grows, and you take it out tax-free.

Tax rate now	Tax rate later	Traditional, after tax	Roth
22%	22%	$4,480	$4,480
22%	12%	$5,054	$4,480
12%	22%	$4,480	$5,054

Traditional: $1,000 × 1.06³⁰ × (1 − tax rate later). Roth: $1,000 × (1 − tax rate now) × 1.06³⁰. Ignores state taxes and assumes the withdrawal is qualified.

With the same rate now and later, the results are identical. Taking 22% off before growth or after growth gives the same answer, because the order of multiplication doesn't matter. The only thing that separates the two is a difference in tax rates:

• If your rate later will be lower than now, traditional comes out ahead.
• If your rate later will be higher than now, Roth comes out ahead.

The rate that matters is your marginal tax rate, the rate on the next dollar of income, since that's the tax a contribution saves now or a withdrawal adds later.

Try it yourself

Set both rates the same, then change one. Notice that the return and the number of years change the size of the gap, but never which account wins.

What tips the balance

You can't know your future tax rate, but some situations point one way:

• Early in a career, or in a low-income year, your rate now may be lower than it will be later, which favors Roth.
• In your highest-earning years, your rate now may be higher than in retirement, which favors traditional.
• Uncertainty itself is a reason some people split contributions between the two. Many workplace plans allow some or all of your contributions to be Roth, so splitting is often possible.¹

Other differences

• Required withdrawals. Roth IRAs and Roth accounts in 401(k) and 403(b) plans have no required minimum distributions while the owner is alive. Traditional accounts do.²
• Access to contributions. Money you contributed to a Roth IRA, but not its earnings, can be withdrawn without tax, because it was taxed going in. Withdrawals come out of contributions first.³
• What makes a withdrawal qualified. For earnings to come out of a Roth IRA tax-free, the account generally needs to be at least five years old and you need to be 59½ or older, or meet another condition such as disability.³
• Income limits. Roth IRAs have income limits on who can contribute. Roth contributions to a 401(k) don't.⁴ IRAs has the current limits.

You can also move money from a traditional IRA into a Roth IRA later, called a Roth conversion. The amount converted is generally added to your taxable income for that year.⁵

Key takeaways

• With the same tax rate now and later, traditional and Roth give identical results.
• A lower rate later favors traditional; a higher rate later favors Roth.
• Roth IRAs and Roth 401(k)s have no required withdrawals during your lifetime, and Roth IRA contributions can come out without tax.
• Since future tax rates are unknown, many people split contributions between the two.

Check your understanding

Your tax rate is 24% now, and you expect exactly 24% when you withdraw. Which choice leaves you with more after tax?

1. Roth, because its withdrawals are tax-free.
2. Traditional, because more money goes in.
3. Neither. With equal rates, they come out the same.

Which situation points most toward Roth contributions?

1. A first job with a low income that you expect to rise a lot over your career.
2. Your highest-earning years, expecting a much lower income in retirement.
3. A plan to spend all of the money within two years of making the contribution.

What's next

IRAs offer both versions too, with their own limits and income rules. IRAs covers them.