John Zeidler, MSA, CPA & Carl Zeidler, CFPⓇ, MSFS
One of the most common questions we get as financial advisors is, “What’s the difference between a Roth IRA and a traditional IRA?”
There is so much confusion around the different names of retirement accounts; 401(k), 403(b), 457(b), deferred comp, SEP IRA, Simple IRA, traditional IRAs, etc. From the perspective of the employee (you), all of these various accounts are exactly the same. They may have different amounts you can put in in any given year, different ways contributions are made, some may have employer matches, but the bottom line is that they are all taxed exactly the same way. When the money goes in, you get to deduct that amount from your taxes. After the money is in the account you can buy and sell as much as you want and it will create absolutely no tax effect. BUT, when you take the money out every penny of it will be subject to taxes exactly as if you earned it that year. This is what we call “tax deferred”. You are “deferring” the tax liability into the future. A lot of pleasure in the short term, but potentially a lot of pain in the long term.
Is there another way to do it? Yes. This is where Roth accounts come in. Roth accounts are any retirement account with “Roth” of “after-tax” in the name, that is, a Roth IRA or Roth 401(k). These work exactly the opposite way as all the other retirement accounts. When the money is put in the account you get absolutely no tax benefit whatsoever. If you contribute $6,000 to a Roth IRA, you will still be paying taxes on that $6,000 in that year. Once the money is in the account it can grow, grow, grow with absolutely no tax ramifications (just like the tax-deferred accounts), BUT when you take that money out it will be 100% tax free. Basically, you pay the tax upfront, and in return the IRS will never be able to touch that money ever again. PLUS, a Roth IRA can be left to your kids (or any other family members or friends) and it can stay in the account and grow 100% tax free for ten years after your death.
Now that you understand the difference between the two, let’s talk about which one you should contribute to. Basically, it comes down to tax rates. Where are you now, and where do you think you’ll be? Now this is a whole lot more complicated than one might think. Most people will make a blanket statement like, “I’m making money now, and in retirement I’ll be making less, so I’ll be in a lower tax bracket in retirement, so I’m going to contribute to a traditional IRA. HA. Take that financial advisor.” Not so fast.
Let’s say you and your spouse are used to living off of $100,000 per year. Let’s also say you’ve both saved all of your money for retirement in tax-deferred accounts such as traditional 401(k)’s and traditional IRA’s. You have two kids and a nice home, both of which generate a nice tax deduction each year.
Well, by the time you get to retirement you’ve paid off your home so you’re no longer able to deduct your mortgage interest, and your kids have moved out of the house (hopefully) which means you’ve lost the child tax credit. You were used to living off of $100,000, but now you want to travel more so you’d like $120,000 in retirement; you have $20,000 coming from social security, $30,000 in pensions, and the final $70,000 you take from your retirement accounts (fully taxable).
Guess where you were while you were working? The 12% tax bracket.
Guess where you will be in retirement? The 22% tax bracket.
Guess where your spouse will be if you pass away (or vice-versa)? The 24% tax bracket.
This doesn’t even account for the risk of tax rates going up in the future. As I’m writing this the current US National Debt is $28 trillion and inflation is higher than it’s been in almost 40 years. Tax rates are already set to rise in 2026, when the Tax Cuts and Jobs Act of 2017 is set to expire…as long as Congress does absolutely nothing (which they’re great at!).
I digress. The bottom line is that there are a lot of moving parts, but for many the Roth option may be best. To know for sure, a comprehensive tax analysis would need to be done, which is something we love to do. If you’re currently saving, we can discuss whether or not it makes sense to contribute to a Roth option. If you’re done saving and already retired, we can look at if it makes sense to move money from (convert) tax-deferred accounts to Roth IRAs. The deadline to contribute to an IRA (either Roth or Traditional) is April 15th following the end of the tax year. The deadline for Roth conversions is December 31st of the current tax year.
If you are interested in a complimentary tax analysis, please call our office at (217) 854-2691 and speak to Lynne to schedule a time to visit with John and Carl.
Wall Street Financial Group, Inc. is a Registered Investment Adviser in the states of Illinois, Missouri, and Tennessee. Carl Zeidler and John Zeidler offer investment advice through Wall Street Financial Group, Inc.
Neither the firm nor its agents or representatives may give tax or legal advice. Individuals should consult with a qualified professional for guidance before making any purchasing decisions.