​​Tax differences: Traditional vs. Roth plans

Looking at retirement accounts, two modifiers – “traditional” and “Roth” – dominate much of the discussion.

They apply to individual retirement accounts and corporate 401(k) savings plans, as well as 403(b) savings plans for nonprofits.

The difference lies in how the money is taxed:

• In traditional accounts, taxes are deferred until the money is withdrawn – presumably during retirement, when the accountholder might be in a lower tax bracket. After age 70.5, accountholders must take an annual, taxable required minimum distribution (RMD).
• In Roth accounts – named for the late Sen. William Roth Jr. – the money is taxed up front, but then earns interest and appreciates tax-free. Roth accounts also have more flexible rules for withdrawals. There are no RMDs; in fact, Roth plans don’t require any withdrawals until the accountholder dies.

Essentially, the difference lies in whether one pays taxes sooner or later. The trick is in estimating whether your income will change following retirement and, if so, how much. But the various accounts also differ in the amounts one can contribute per year, which, in turn, are subject to limits depending upon your total income and whether you also have an employer-sponsored retirement plan. A financial professional can explain how the rules would apply to your specific situation.

Generally, the traditional approach favors folks who expect to be in a lower tax bracket after retirement. If you have a pension or expect to have a similar or higher income in retirement, you would most likely benefit from a Roth IRA.

For example, if you planned to save $5,500 for retirement each year, how would the results compare? Assuming a 7 percent annual return and a 30-year time horizon, a traditional IRA would net you almost $17,000 more than a Roth IRA – if your tax rate dropped from 25 percent to 15 percent when you retired. However, if your retirement income put you in a higher tax bracket – say, 35 percent – that same Roth IRA would total a whopping $83,000 more than a traditional IRA. That’s because the money in the traditional IRA would be taxed at the higher rate.*

Some of the key things to factor into your choice of retirement account are your liquidity needs, time horizon and expected income now and in retirement. This will help you determine which type of account would be better for your financial strategy. As shown above, 30 years of tax-free gains can be very beneficial, but your current tax bracket can really make those benefits fluctuate.

* The above examples in this article are for illustrative purposes only and each individual situation will be different.

This article was written by Adam B. Carlat, a Glendale-based financial adviser and Chartered Retirement Planning Counselor® with One2One Wealth Strategies. Questions? Call (623) 850-0016 or email Adam@121ws.com.

The opinions expressed in this article are for general information only and are not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your tax, legal and/or financial services professional regarding your individual situation. The views expressed in this letter are those of the author and may not necessarily reflect those by PlanMember Securities Corporation.

Representative is registered with and offers only securities and advisory services through PlanMember Securities Corporation, a registered broker/dealer, investment advisor and member FINRA/SIPC. 6187 Carpinteria Ave., Carpinteria, CA 93013, (800) 874-6910. One2One Wealth Strategies and PlanMember Securities Corporation are independently owned and operated. PlanMember is not responsible or liable for ancillary products or services offered by One2One Wealth Strategies or this representative.