What Type of IRA Should You Use – A Roth IRA or A Traditional IRA?

The answer depends on good your crystal ball is. You need to guess if your tax rate be higher or lower in the future. Your answer is important because the accounts, at their core, are very similar. The major difference is that a Traditional IRA is tax-deferred, meaning that you pay no tax on your contribution today and no tax until you withdraw the money. When you do withdraw your money, it is taxed as earned income. A Roth IRA, on the other hand, is tax free, meaning that you put after-tax dollars in the account, but withdrawals are tax-free in the future.

Since no one knows the future, you can take one of three paths. You can hedge your bet, plan conservatively and hope for a better outcome or assume that nothing will change in the future.

If you decide to hedge your bet, you can save for retirement by putting some money in a Traditional IRA and some money in a Roth IRA. This way, no matter what happens in the future, you have optimized part of your holdings regardless of the final outcome.

Your second option is to plan conservatively and know that most likely you will end up better than you planned. Many people feel that taxes are lower now than they will be for many years to come regardless, of who is elected President in November. There are many reasons for this, such as a $10 trillion national debt and a Social Security system that is about to become a drain on the treasury.  If this is your chosen path, your best option is to use a Roth IRA. By paying taxes today when rates are low, you will have a lower lifetime tax bill.

Lastly, you can assume that taxes won’t change in the future. Typically, when people retire, their income is lower that it was during their working years. In this case, it makes sense to use a Traditional IRA. With this strategy, you get a tax deduction today and will pay taxes in the future at a lower rate than you would have paid today.

The most important thing to remember, no matter which strategy you choose, is that saving for your retirement and starting as early as possible is critical to have a successful retirement.