Which Is Better: Roth or Deductible IRA?

The answer depends a lot on your tax bracket today and tomorrow.

So, how do you decide whether a traditional or a Roth IRA belongs in your retirement plan?

If your income is too high to deduct regular IRA contributions, the Roth IRA is a great addition to your retirement savings.

Even if you can deduct your IRA contributions, the Roth has clear advantages, primarily the fact that there's no mandatory withdrawal schedule to worry about and that money in a Roth can go to an heir tax-free.

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You also won't have to worry about tax-free withdrawals triggering extra tax on your social security benefits.

What about the financial advantage of getting tax-free versus taxable withdrawals?

Believe it or not, there's no guarantee that -- when all else is equal -- the Roth will beat the regular IRA. You need a crystal ball as much as a financial calculator to know whether it makes sense to give up tax deductions today in exchange for tax-free income tomorrow.

It really depends on what your tax bracket will be when you retire. If you're in a lower tax bracket, the regular IRA will prove to have been a better choice; if you're in a higher tax bracket, the Roth will shine.

An apples-to-apples comparison

Assume that you deposit $4,000 a year in a regular IRA and just $3,000 in a Roth -- because that's all the regular IRA really costs you if you're deducting contributions in the 25% bracket.

Assuming the money in the accounts earns at the same rate, at the end of any period, the spendable amount in the accounts will be identical.

Sure, the deductible IRA will hold more money. But you'll owe tax on withdrawals. Assuming a 25% rate, the after-tax amount will be the same as the tax-free amount coming out of the Roth IRA.

As noted, however, there is a way to give the Roth a big advantage. Put a full $4,000 into the account each year rather than a stunted $3,000, and increase your contribution as the limits rise.

But what if you find yourself in a lower tax bracket in retirement? Then you might be kicking yourself for passing up regular IRA deductions back in the bad old days of high income tax rates. Assuming there will still be an income tax when you retire (a pretty good bet), how can you know whether you'll be in a higher or lower bracket?

You can't. In the past, it was generally assumed that retirees would fall into a lower tax bracket because they'd have less taxable income. Now, however, it's increasingly likely that retirees will maintain their income levels.

Ironically, because opting for a Roth will reduce taxable income in retirement, it's more likely that you'll be in a lower bracket (which is a minus for the Roth); conversely, using a regular IRA will boost taxable income in retirement, possibly pushing you into a higher bracket (which is a minus for the regular IRA).

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