To Roth or not to Roth – this is a question that we often hear from clients who participate in their employer sponsored 401K or 403B plans (or if not covered by an employer sponsored plan, which is rare, then a traditional or Roth IRA). Often these plans offer a Roth option in addition to the traditional tax-deductible salary deferral. For the most part, the answer to this question hinges on one variable – do you believe your tax bracket will be higher now or in retirement? Roth contributions have no immediate tax benefit whereas traditional contributions are income tax deductible. And vice versa in retirement – Roth withdrawals in retirement are tax free whereas, traditional withdrawals are entirely taxable. Although it may be difficult to predict where you’ll be income-wise in retirement, conventional wisdom says that when compared with your highest earning years, your income, and hence your tax bracket, in retirement is likely to be lower. If we assume this is true, then the current tax deduction for high income earners is likely more valuable than the tax-free withdrawal in retirement. By this rationale, for younger people just beginning their careers and thus probably in their lowest earning years, Roth contributions might make sense.
There is a caveat to making only tax-deductible contributions which is worth considering – because your IRA withdrawals in retirement will be considered income when they are taken, even if you are in a lower tax bracket, that additional income could kick you into a higher tax bracket and thus increase the cost of Medicare premiums. Having a Roth bucket to pull money from (which won’t be considered income) offers increased flexibility, which could prove valuable as well. This would support the case for making at least partial contributions to the Roth account. Ultimately, when it comes to retirement savings there is no real right or wrong answer per se and it comes down to not only what makes mathematical sense, but also what feels right. Either way, what’s most important is that saving is happening and by taking advantage of the compounding effect, a little will go a long way.
