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Same Spendable Income – Roth IRA vs Traditional IRA

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When it comes to saving for retirement, individuals have a variety of options available to them. Two of the most popular types of retirement accounts are Roth IRA and traditional IRA. While both of these types of accounts offer certain advantages, it’s essential to understand the key differences between them.

One of the main differences between Roth IRA and traditional IRA is how they’re taxed. With a traditional IRA, your contributions to the account are tax-deductible. This means that you won’t have to pay taxes on the contributions or any investment earnings until you start withdrawing money from the account.

On the other hand, Roth IRAs are funded with after-tax dollars. This means that you’ll pay income taxes on the contributions when you make them. However, the investment earnings in a Roth IRA grow tax-free, and you won’t have to pay taxes on any qualified withdrawals.

So, which type of IRA is better for your situation? It comes down to your individual circumstances and financial goals. One way to compare the two is by looking at their impact on your spendable income.

Let’s assume that you’re 35 years old and planning to retire at age 65. You’re currently making $100,000 per year and contributing $6,000 annually to your retirement account. We’ll assume a 7% annual return on investment and a 22% marginal tax rate.

If you contribute $6,000 per year to a traditional IRA, your taxable income would be reduced by that amount. This would lower your tax bill by $1,320, leaving you with $4,680 in after-tax spendable income. Over 30 years, you would have contributed $180,000 to the account, and your investments would grow to $672,538. When you withdraw this money during retirement, you would owe taxes on the full amount, leaving you with $523,346 after taxes.

If you were to contribute $6,000 per year to a Roth IRA, your after-tax spendable income would be $4,680 per year. Over 30 years, you would have contributed the same $180,000, and your investments would also grow to $672,538. However, you wouldn’t have to pay any taxes on the qualified withdrawals, so you’d have the full $672,538 available to use in retirement.

In this scenario, both types of IRAs would give you the same spendable income during your working years. However, the tax treatment of withdrawals would be different. While you would pay taxes on the full amount of withdrawals with a traditional IRA, you wouldn’t owe any taxes on qualified withdrawals from a Roth IRA.

Of course, there are other factors to consider when choosing between a Roth IRA and traditional IRA. For example, if you expect to be in a higher tax bracket during retirement, a Roth IRA may be a better option since you’ll be paying taxes on the contributions at a lower rate. Conversely, if you expect to be in a lower tax bracket, a traditional IRA might be more advantageous since you’ll pay taxes on the withdrawals at a lower rate.

Ultimately, the key is to speak with a financial advisor and assess your individual situation to determine which type of IRA is best for your retirement goals. By understanding the differences between Roth IRA and traditional IRA and the impact on your spendable income, you can make an informed decision about how to save for a comfortable retirement.