Roth or Traditional IRA? Why It Comes Down to Your Tax Bracket
In our latest video, Daniel Andersen, CFP®, and Trevor Stone, CFP®, EA, advisors at Parkshore Wealth Management, break down the difference between a traditional and Roth IRA, and why the right one for you may come down to a single comparison: your tax bracket today versus the bracket you expect to be in during retirement. Watch the video below to see how Daniel and Trevor walk through it, or keep reading for the highlights.
How a Traditional IRA or 401(k) Works
When you put money into a traditional IRA or traditional 401(k), you typically get a tax deduction in the year you contribute. The money then grows in the account until you withdraw it in retirement. At that point, every dollar you take out is taxed as ordinary income, the same as a paycheck.
How a Roth Account Works
A Roth account works a bit in reverse. You fund it with after-tax dollars, meaning you contribute money without getting a tax deduction up front, but the account then grows tax-free for as long as it stays invested. When the money comes out in retirement, qualified withdrawals are not taxed. In exchange for skipping the upfront deduction, you are aiming to avoid taxes on both the contribution and its growth later on.
“High” and “Low” Are Relative to You
It might seem like the Roth is always the better deal, since it avoids future taxes altogether, but that is not necessarily the case. If your income puts you in a high bracket right now, say 24%, 32%, or 35%, taking the deduction on a traditional account while your income is high can be worthwhile. If your bracket is low right now, you are giving up less by skipping the deduction and choosing a Roth instead.
The important detail is that “high” and “low” are not about how your bracket compares to a neighbor’s or a coworker’s. They are about how your bracket now compares to the bracket you expect to be in later, in retirement. The comparison is with your own future self.
When Traditional and Roth Come Out the Same
There is a case that is easy to overlook: What happens if your bracket today and your bracket in retirement turn out to be about the same? If you are in the 24% bracket now and expect to be in the 24% bracket in retirement, a traditional account and a Roth account work out to roughly the same result mathematically. Neither one has a built-in advantage in that scenario.
The two account types diverge when there is a real gap between your current bracket and expected bracket. Taking the deduction while your income and bracket are high, then withdrawing the money later when your bracket is lower, can be a way of managing when you pay tax on those dollars.
The reverse can also be true: If your bracket is low now and you expect it to be higher later, contributing to a Roth now may make more sense than taking a deduction you would not benefit from much anyway.
What to Weigh Before Deciding
Choosing between a traditional and a Roth account comes down to comparing your tax bracket now to the bracket you expect in retirement. If there's a real gap between the two, you can use it to your advantage. Consider taking the deduction while your income and bracket are high, then let the money grow and come out later when your bracket is lower.
If your bracket is low now and you expect it to be higher later, contributing to a Roth may make more sense than taking a deduction you wouldn't benefit from much anyway. And if you expect to land in about the same bracket either way, it may not make much difference which one you choose.
This is the kind of question we help clients think through as part of a broader financial plan. If you or someone you know is thinking about how retirement contributions fit into a retirement and tax strategy, we invite you to schedule a conversation with an advisor at Parkshore Wealth Management.
Whether a Roth contribution or conversion makes sense depends on your own situation, and a conversion creates taxable income in the year it is done. Speak with a financial advisor or tax professional to determine what is appropriate for you.
This material was written in collaboration with artificial intelligence (Claude) derived from sources believed to be accurate. This information should not be construed as investment, tax, or legal advice.
Parkshore Wealth Management is an independent, fee-only Registered Investment Advisor with offices in Granite Bay and Folsom, CA, and Lehi and Logan, UT. We partner with financially responsible individuals and families who are eager to take positive steps that will allow them to use their money to build the life they desire. The firm is led by Daniel Andersen, CFP®, a member of NAPFA, the country’s leading professional association of fee-only financial advisors.