TerpTax: Roth vs. Traditional IRAs

By Samuel Handwerger, CPA, Faculty Advisor for TerpTax

You've probably heard about IRAs as “a way to save for retirement.” But let’s dig into the two main flavors: Traditional and Roth IRAs and why choosing between them isn't as straightforward as it might seem at first glance.

Traditional IRAs work like a deal with Uncle Sam: You get a tax break now by deducting your contributions from your current income, but you'll pay taxes when you withdraw the money in retirement. Think of it as tax-deferred savings—you're essentially pushing those taxes down the road.

The Roth IRA flips this arrangement on its head. You won't get any immediate tax benefits since you're contributing with after-tax dollars. However, once you reach retirement age, you can withdraw both your contributions and all the investment gains completely tax-free. Plus, Roth IRAs come with some nice perks: There are no Required Minimum Distributions (RMDs) forcing you to withdraw money at a certain age, and you can access your contributions before retirement without penalties if you need to.

Now, conventional wisdom often pushes young workers toward Roth IRAs. The thinking goes, "You're probably in a lower tax bracket now than you will be in retirement, so pay the taxes now while they're lower!" And while that logic can make sense, it’s worth pumping the brakes before automatically jumping on the Roth bandwagon.

Consider this: Tax laws have changed dramatically over the past few decades, and they'll likely continue to evolve. What looks like an optimal choice based on today's tax code might not pan out as expected 40 years down the road. Your career trajectory, future income and retirement lifestyle could all look very different from what you envision today.

The tax deduction from a Traditional IRA actually might be more valuable than you think, especially if you invest those tax savings. That extra money working for you over decades of compound growth could potentially offset higher taxes in retirement. And who knows? You might end up in a lower tax bracket in retirement than you expected, making those deferred taxes less painful than anticipated.

The reality is that both types of IRAs can be excellent retirement savings vehicles. Instead of trying to predict which will be definitively "better," consider your current financial situation, your confidence in future tax rates, and your need for flexibility. You might even decide to hedge your bets by maintaining both types of accounts, giving yourself tax diversification in retirement.

Remember, what matters most is consistently saving for retirement. Though the “tax treatment” is important, it shouldn't overshadow the fundamental goal of building your nest egg. The best IRA is the one that encourages you to save regularly and invest wisely for your future.

Samuel Handwerger is a full-time lecturer in the accounting and information assurance department at the University of Maryland’s Robert H. Smith School of Business. He serves as faculty advisor to TerpTax, a nonprofit organization affiliated with UMD that provides free tax preparation services for low to mid-income individuals in the University of Maryland, College Park community, according to VITA/TCE guidelines.