2018-11-06 update: I realized I missed an important point, which makes the comparison come out much closer than I previously realized. See the addition at the end of the post.


Hopefully this one will be short. I don’t think anythere here is particularly insightful or unique, but I’ve found existing explanations of the differences between a Roth and a Traditional IRA to be surprisingly convoluted and complicated. I worry that people will read those explanations and come away with the feeling that one isn’t better than the other, it’s just a large set of complicated tradeoffs. While that’s technically true, I think that for most people one will very likely be better: a Traditional IRA.

By far the biggest difference between a Roth IRA and a Traditional IRA is when your contributions are taxed. Your Roth contributions are taxed now, while your Traditional contributions are taxed when you withdraw them. So if you expect your current income tax rate to be higher than your tax rate during retirement, then you should prefer a Traditional IRA. Taking this one step further, that seems very likely.

If you expect to actually retire and stop working by the age of 70 (when you’re required to start making withdrawals from a Traditional IRA) it seems pretty unlikely that somehow you’ll have more income than when you were still working full-time. For you to be retired and making more income than when you were working, something’s gone very right for you. Thinking about this from an expected utility perspective, you probably shouldn’t mind too much that a Traditional IRA will cost you a bit of extra money in that case, since it will save you a lot of money in the case where you retire and have less income than you did when you were working - which is exactly the case in which you care a lot about saving money.

Like I said earlier, this is not the only difference between a Roth and a Traditional IRA by any means. But my guess is that, for most people, this difference dwarfs the rest.

To be fair to Roth IRAs, there is one big benefit that I should mention. Roth IRA contributions can be withdrawn at any time without penalties, which is not true of a Traditional IRA. So if your financial situtation is unstable enough that you think there’s a good chance that you will need to withdraw your IRA contributions before the age of 59, then I concede that a Roth IRA could make sense.

Instead of listing out all the other less consequential differences between the two types of IRAs just for the sake of completeness, I’m going to leave it here. At any rate, there are plenty of other online resources that do this (to a fault, IMO), if that’s what you’re looking for.

Not that you thought I was, but to be clear, I’m not a tax expert so you should take everything that I’ve said here with a fairly good-sized grain of salt. Also, if you know more about this than I do and you think I’ve completely got it wrong, please educate me in the comments!

2018-11-06 update:

And yet there’s more…

My previous analysis is correct, but it’s comparing 1 pre-tax dollar contributed to a Traditional IRA vs. 1 pre-tax dollar contributed to a Roth IRA. But that’s not fair! You can contribute more pre-tax dollars to a Roth IRA because A) contributions are post-tax and B) the contribution limits are the same. As a simple example, imagine the contribution limit was $5,000 and your current income tax is 50%. By contributing $5,000 post-tax dollars to a Roth IRA, you’re effectively contributing $10,000 pre-tax dollars. So, a complete analysis should take this into account. And for that… next post!