The ROTH IRA’s main advantage over a traditional IRA is that is grows tax free. Dollars that you have already paid tax on are used to fund the IRA. You then pay no tax on the draws when you take them later in retirement. This makes all the investment income over the life of the IRA tax free. So, if you make a contribution for 2015 of $1,000, based on a modest average rate of return of 5%, in ten years you will have gained $550, or 55% on your initial investment, tax free. At a higher rate of return of 7.5%, in ten years you will have made over $900, almost doubling your investment, tax free. Obviously, the younger you can contribute the better. If you hold the investment for 30 years you would more than quaruple your investment at a 5% return and you would have eight times your investment at a 7.5% return.
The ability to contribute to a deductible IRA is phased out in the 25% tax bracket. If you are currently in the 25% tax bracket, you should being shooting to be in the 15% tax bracket at retirement. In this case, contributing to a traditional IRA would save you 10% on taxes. On a $1,000 investment, that would be worth $100. The ROTH would surpass this advantage in two years at a 5% rate of return.
I always try to explain how the ROTH IRA can be a huge advantage to my clients, but often the more real time benefit of the tax deductible traditional IRA is what people are looking for. This is especially true if they are keeping AGI low for early social security or ACA insurance purposes. However, another thing to consider is what pools of money you will be pulling from when you retire. As a tax planner, I love when I have clients that come to me with options. Having a taxable account to draw from and a non taxable account to draw from is the type of options I can help you utilize to keep you tax burden low no matter the cash requirements you have for a given year in retirement.
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