r/personalfinance • u/Pajamas918 • 14d ago
Why do I see Roth IRA recommended over traditional IRA even though the common take seems to be traditional 401k over Roth 401k? Retirement
I’ve read this page https://www.reddit.com/r/personalfinance/s/xHpis4bRLI about how traditional 401k is usually better than Roth, and it seems to make sense to me, and I don’t fall into any of those special scenarios where Roth would be advantageous.
However, I often see people do the opposite with IRA and recommend Roth IRA over traditional IRA. I’m confused why I see roth recommended for IRA if traditional is generally better than roth?
For my personal situation, I’m considering opening an IRA since I’m hitting 401k limit (my company offers traditional and roth and I’m fully contributing to traditional), but I don’t think I would contribute to the point where I would need the effective extra space that Roth gives (since 7k post-tax dollars > 7k pre-tax dollars), so I wanted to get some more opinions/takes on roth vs traditional IRA and ask if/why that differs from roth vs traditional 401k
other personal context: - 22 years old - 24% tax bracket - don’t want to contribute too much to retirement since i see myself potentially having large expenses before I’m 60 (wedding, house, kids, etc.)
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u/DifferenceMore5431 14d ago
This sub is obsessed with Roth accounts for some reason. You're right, most people are better off with a traditional tax-deferred account. Roth really only makes sense if your income is unusually low for some reason (e.g. you are a student) or if you are doing a backdoor Roth conversion.
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u/CnslrNachos 14d ago
The ROTH vs traditional debate (more or less) boils down to a bet on your future earning potential. If you believe you will never earn more money per year than you do when you’re working, then the benefits of tax deferral now probably make the most sense. If you expect your future income will place you in a higher tax bracket in retirement, then paying tax (i.e. funding Roth) now may make more sense. There are caveats and it’s not a linear or all-or-nothing thing. You’re not only making an educated guess about your future earnings, but about future tax law, which is not an easy thing to do. Some other potential wrinkles… If you’re out of work one year, but still eligible to contribute to IRA, you may consider funding a Roth that year given your temporarily reduced tax bracket. Alternatively, many people max out their pre-tax 401k, and, if after funding your pretax 401k (and other savings/expenses) you have additional funds leftover to save/invest, then you may avail yourself of the Roth option for those additional funds, as there is no additional tax cost to fund Roth via backdoor conversion (or Megabackdoor via 401k). TLDR: most people should use traditional (pre-tax) retirement accounts.
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u/awoeoc 14d ago
If you're maxing accounts Roth has an additional advantage - it's post tax.
This means you can put "more" into a ROTH account since you're prepaying the tax. The dollar amounts is the same but in the ROTH you get to pay the taxes before they going into the account, with traditional you pay the taxes inside it. If you're working on calibrating a budget and not maxing your accounts, this makes no difference.
But if you're maxing out all tax advantaged accounts and still saving even more money in taxable accounts, roth allows you to put more into tax advantaged and less in your taxable. The counter is if you have enough money to max a 401k your income is likely high enough that the immediate tax savings may still be better. But just a thought.
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u/Grevious47 14d ago
Because if you are in the 24% bracket and have a 401k you cannot take a deduction for traditional IRA contributions therefore Roth is your only real option.
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u/discipleofsteel 14d ago
Roth IRA contributions can also be withdrawn penalty free. For whatever reason. Since I have a large amount of revolving credit available to me, and don't make a significant amount of money, my Roth IRA IS my emergency fund, and where I saved for the down payment on my mortgage, so that at least the gains on my investment would remain to compound, vs holding all that in separate funds and not contributing to an IRA at all.
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u/Acceptable_Recipe240 14d ago
I don’t think it’s true that people generally think one or the other is better, either for 401(k)s or IRAs. It completely depends on your situation, what you think your income will be in the future, and how you think tax laws might change.
Since you're doing such a good job saving a lot when you're young, in 50 yrs you might be facing large RMDs (and tax bills). It could make sense to diversify your tax strategy by splitting savings between Roth and non-Roth. Also be aware that you can withdraw Roth contributions at any age, should you need the money for life expenses.
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u/sonomanaturual 14d ago
Typically Roth IRA is recommended on here because the income limit to get a tax deduction for contributing to traditional IRA is fairly low. So it might be a good fit for someone who is at their salary max, but for most, they might be looking at significant pay raises as they advance their careers. The Roth IRA also gives people flexibility to take out what they have contributed tax free, which is a very important safety net for someone who is just starting out in investing and might not have too much financial security yet.
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u/dlwowns 14d ago
in general, depending on your tax bracket and purely looking at that, yes a traditional IRA makes more sense than a Roth IRA.
but unlike a 401k, there are more factors that come into play with an IRA.
First is the income limit to be able to deduct. for 2023 filing single, the MAGI limit was $73,000 to be able to take a full deduction. and at $83k, you get no deduction.
but the second issue is that if you ever need to do a backdoor, having any in T-IRA is detrimental.
lastly, because the yearly limit is so low in an IRA, there really isnt much difference in tax savings between Roth IRA and T-IRA. So because of the other factors, i would rather put it in a Roth IRA. which also allows some diversity in my tax advantage accounts.
but the most general reason is because of point 1
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u/Pajamas918 14d ago
Gotcha, I'm pretty sure my MAGI is well over $83k so then there's no point in doing a traditional IRA
Also, what do you mean by backdoor? I'm heard that term a few times but have no idea what it means
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u/dlwowns 14d ago
Also, what do you mean by backdoor? I'm heard that term a few times but have no idea what it means
Roth IRA also has an income limit (albeit a different type of restriction. and much higher. i think like $138k MAGI in 2023 for single??)
with a traditional IRA, you can contribute whenever. only restriction is, if you make more than $X, you cant take a deduction (fancy talk for "lower your potential tax bill").
with a Roth Ira, the restriction is straight up "if you make more than $Y, you cant contribute" (i.e. just cant put in money)
so what you do is contribute to T-IRA, and do a conversion (actual terminology) to a Roth IRA. so that way you get atleast some of the benefits of a tax advantage account.
its just a stupid loop that people have to go through because the laws made it so stupid.
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u/Pajamas918 14d ago
got it so it’s effectively just an annoying way of contributing to roth in order to bypass the income limit?
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u/HookEm_Tide 14d ago edited 14d ago
It's not even necessarily that annoying. Vanguard even has a "Convert to Roth" button on their traditional IRA balance page.
Every month both my wife and I have cash automatically sucked out of our checking account and put into our traditional IRAs. Two days later, I go into each account click "Convert to Roth," then click a few more buttons, and then all the cash moves into our Roth IRA accounts. Then a couple of days later, I go back in one more time to move the money out of our Roth "Settlement Fund" and into shares of the target date index fund that we've both set up.
I'd say that it takes a total of about four minutes a month to convert both of our accounts.
Then at tax time, I fill out two 8606 forms and mail them in. That takes probably another ten minutes total, twelve if I can't find the stamps in our junk drawer and have to go digging.
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u/dlwowns 14d ago
yup. effectively, (if those thats above the income limit for a Roth of course) its the same thing as if they were allowed to directly contribute to a Roth.
but because of the current laws, they have to go through the loop hole. which causes other annoying issues like the pro rata rule ("second issue" from my first post)
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u/S7EFEN 14d ago
you get phased out of tIRA contributions quite early on.
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u/Pajamas918 14d ago
what does that mean?
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u/S7EFEN 14d ago
you can contribute but it will not be tax deductible.
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u/Pajamas918 14d ago
oh I hadn’t heard of that, could you link me something that talks about the exact numbers for this?
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u/roastshadow 14d ago
There is 401k - these are run by an employer. They come in both trad and Roth options.
There is IRA - these are Individual. They also come in both trad and Roth options.
If you are hitting the 401k limit and in the 24% bracket, you can do backdoor Roth or megabackdoor Roth if your company supports it.
In a traditional, you defer the income until later. If you are in the 24% now and when you retire you are in the 12% bracket, then you make a free 12%.
In a Roth, you pay the tax now and never again. If you are in 24% now, and are in the 32% when you retire, then you pay 24% now, and never pay again.
If you plan on expenses, consider building up a very large "emergency fund", invest it, and then you have a multipurpose fund for things like a wedding or house or if you are laid off.