Hey y’all, Brian here.

It’s time for me to weigh in on the classic matchup: Roth IRA versus Traditional IRA. This is an important battle in the world of retirement investing, and I think it’s about time this issue was solved.

I will deliver, with mathematical certainty, the superior retirement investing account… with minimal caveats. Let’s get into it!

On the go? Watch my video instead:

I am going to showcase three different investment scenarios for this analysis so be sure to stay with me until the end.

First things first, a quick and dirty explanation of these two investment vehicles.

## Accounts Explained

Roth and Traditional IRAs are investment accounts. They are similar to your typical brokerage account in that you can invest in different investment funds or even individual stocks.

Where these two accounts differ from your standard brokerage account is in the tax treatment.

### Typical Brokerage Account

When you invest in a typical brokerage account, first you pay taxes on your income, then you fund your brokerage account and pick your investments. You are then taxed on dividends you receive and when you sell your shares you are taxed on the gains.

Investing in a Standard Brokerage Account

Since we are analyzing these accounts through the lens of retirement investing, I will use long-term capital gains instead of short-term capital gains.

### Traditional IRA

The traditional IRA is funded with pre-tax dollars.

This means that you do not need to pay income tax on the money that you put in your traditional IRA, which lowers your tax bill.

On top of that, anything that happens within the account is not taxed – that includes dividends and capital gains. As long as you do not withdraw the money from the account, you will not be taxed.

Once you do withdraw though, you are taxed in the ordinary income tax bracket.

Investing in a Traditional IRA

### Roth IRA

The Roth IRA, on the other hand, is funded with post-tax dollars.

Just like with the typical brokerage account, you still have to pay taxes on the income that you use to fund the Roth IRA.

Once the money is in the account, it behaves similarly to the traditional IRA – dividends and capital gains are not taxed. Where the Roth IRA really shines is when you withdraw the cash from the account; you do not pay any taxes at all.

Nothing on the gains or dividends!

Investing in a Roth IRA

So to quickly recap:

Typical Brokerage Account: You work and make money, pay taxes on that money, put that money in the account and invest, and then pay taxes when it increases in value.

Traditional IRA: You work and make money, put it in the account without paying taxes, and then when you pull it out of the account you pay taxes.

Roth IRA: You work and make money, pay taxes on that money, put that money in the account, invest, and then you get the benefit of not paying taxes on any of your gains!

Invest in a Standard Brokerage vs Traditional IRA vs Roth IRA Account

Now that you understand the two combatants, let’s dive into how these details play out in real life.

## Investing Context

In 2023, the maximum amount of money you can invest in an IRA (Traditional or Roth) is $6,500 for someone under 50 years old. That being said, if you make more than $73,000 in a year, you are not allowed to contribute the full amount to a traditional IRA.

For the Roth IRA, the cap is much higher – you can make as much as $138,000 until you are no longer allowed to contribute the full amount.

With that in mind, I am going to assume for this investing scenario:

You have a maximum annual salary of $73,000.

You are 30 years old.

You plan to retire at 65.

You will only be investing in your IRA of choice for retirement where the investments will be the same in each IRA. The investment returns will also be the same so that we can have an apples-to-apples comparison.

You will put money into the account at the age of 30, it will grow for 35 years, and you will spend that chunk when you retire at 65.

The amount invested at 31 will also grow for 35 years and be spent at the age of 66. The amount invested at 32 will grow for 35 years and be spent at the age of 67, and so on.

In this way, you will invest for 35 years and will have 35 years of income – from the age of 65 to 100.

## ROUND 1

#### Income $73,000 | Investment $5,000

Let’s start with the traditional IRA.

The primary advantage of the traditional IRA is that you get to invest pre-tax dollars. With an income of $73,000, your top tax bracket is 22%.

### Understanding the Tax Bonus

Let me show you an example using real numbers of how this plays out with your yearly salary.

If you make $73,000 per year, after federal income tax, social security tax, and Medicare tax, your take-home pay is about $59,100.

If you first invest the full $6,500 into a traditional IRA, you reduce your taxes by 22% of $6,500, which is about $1,400.

Unfortunately, you cannot put that tax savings into your Traditional IRA or Roth because you are already capped out on IRA contributions.

To keep things simple for the competition between Roth IRA and Traditional IRA, we will assume that you only have $5,000 to invest. After all the bills are paid, groceries, vacations, etc., there is only $5,000 available for retirement investing.

If choose to invest in the Roth IRA, then you can only invest $5,000. But if you choose to invest in the Traditional IRA, you can invest more because of the 22% tax savings which comes out to $6,410.

### Roth IRA versus Traditional IRA

Let’s check out this flow chart so we can better visualize how taxes are affected when you put money in your Traditional IRA versus Roth IRA.

Here we can see in both cases with the Roth and the Traditional, we have a salary of $73,000.

Investing in a Roth IRA vs Traditional IRA

Roth IRA:

You have to pay taxes first on that $73,000 salary, so your remaining cash is down to $59,100. And if you can afford to invest $5,000 into your Roth, then that leaves $54,100 left for your expenses.

Traditional IRA:

Before paying taxes, you get to shield your investment from those taxes. Your remaining cash is a smaller amount, thus you pay a smaller amount of taxes. You can see in this case, you only pay $12,490 compared to the $13,900 in the Roth IRA example.

Now let’s calculate how much money you end up with after 35 years of investing and it’s time to start taking your money out.

Taking the money out is where the Roth IRA shines over the Traditional IRA, BUT…. will it be enough?

### Round 1 Accumulation

Both accounts will be invested in the S&P 500 for the complete duration of the competition.

The S&P 500 has a historical annualized return of 6.632% which assumes dividends are reinvested and the total return is adjusted for inflation. All of our calculations will be adjusted for inflation so we can look at our results in today’s dollars, which is easier to visualize.

Traditional IRA:

So, using this investment return calculator and assuming historical annualized returns and historical inflation, the Traditional IRA S&P 500 investment of $6,410 at the age of 30 will be worth $60,663 after 35 years at the age of 65.

Roth IRA:

The Roth IRA S&P 500 investment of $5,000 at the age of 30 will be worth $47,319.

### Social Security Benefit

But keep in mind, at 65 years old you will also have access to your social security payments which will impact our calculations.

In both scenarios, you are making $73,000 per year at 30 years old. Using this calculator, the estimated social security benefit per year starting at the age of 65 will be about $27,684.

Now this brings the total cash at the age of 65 for the Traditional IRA investor up to $88,387 and the total yearly cash of the Roth IRA investor is up to $75,003.

This difference seems pretty large but now we must calculate how paying taxes will affect withdrawing this cash from the different accounts.

### Accounting for Taxes

Roth IRA:

The Roth IRA investor is only taxed on the Social Security benefit. Now, you are not taxed on ALL of your social security, but in this case, 85% of the Social Security benefit is taxed under the regular income tax bracket.

To me, it seems ridiculous to be taxed again since we are already taxed our whole working lives to pay for social security but whatever.

After paying less than $1,000 in taxes on the $27,684 Social Security benefit, the Roth IRA investor is left with $74,035 to spend for the year. Not bad!

Traditional IRA:

On the other hand, the Traditional IRA investor has to pay income taxes on the social security benefit and the entire amount withdrawn from the Traditional IRA – which comes out to nearly $11,000 in taxes.

Even though the tax bill is more than 10 times higher, the Traditional IRA comes out on top with an after-tax income of $77,565 – winning by $3,530.

### Savings on Taxes

Traditional IRA:

The secret to understanding why the Traditional IRA wins lies in the progressive tax structure.

Income Tax Bracket 2023

Roth IRA:

### Round 1 Conclusion

In conclusion, the Traditional IRA wins when you are able to save big taxes upfront – in this case, 22%.

So you may be asking, what happens if your tax bracket is lower than 22%?

If you actually did ask that well done, because that is a great question! Let’s see what happens if your income is $58,000 per year which makes your top tax bracket 12%.

## ROUND 2

#### Income $58,000 | Investment $5,000

Income Tax Bracket 2023

The first thing that gets affected is the bonus investment due to tax savings that the Traditional IRA investor enjoys. Since we are now in a lower tax bracket, the tax savings are reduced from 22% down to 12%.

If we keep our assumption that you can only afford to invest $5,000 after taxes, then the Traditional IRA investor can deposit $5,682 instead of $6,410.

The Roth IRA investor is unaffected at this stage since the Roth deposits are post-tax.

### Round 2 Accumulation

Using the same assumptions as before, dividends reinvested, inflation-adjusted, and historical annualized returns, the Roth IRA still ends up with $47,319, but the Tradition IRA is down to $53,773 after being invested for 35 years.

Nearly $7,000 less than the previous example.

### Round 2 Conclusion

Finally, after paying taxes to withdraw the money, the Roth IRA actually comes out on top with an after-tax withdrawal of $70,280 compared to the Traditional IRA $68,854 after tax.

Now our conclusion gets refined a little bit! The superior account depends on what your taxes are at the time of your investment.

In this scenario, we are also assuming our entire retirement income is coming from the one investing account and Social Security. If we start to factor other sources of income into the equation, then the tax calculations change a bit – which brings us to our next example.

## ROUND 3

#### Income $73,000 | Investment $6,500

Now I know some of you are asking, “What if I want to top off my IRA by investing the full $6,500? Does the advantage disappear?” No, but the results may surprise you.

If you are topping off your Traditional IRA then you will have to make use of a different investing account for your tax savings. For this next comparison, we will invest our tax savings into a standard brokerage account that is NOT shielded from taxes.

### Utilizing the Typical Brokerage Account

In this example, we will assume an income of $73,000 and we will use the same market returns as the previous examples. We are back up to the 22% tax bracket so the Traditional IRA investor saves $1,430 when $6,500 is deposited into the Traditional IRA.

To put this another way, with a $73,000 salary, you can expect to take home about $61,500 after taxes and deductions. If you invest $6,500 into your pre-tax Traditional IRA, then your take-home income only decreases by $5,070 because of the tax savings of $1,430. So for this comparison, we will take that additional $1,430 and invest it in a standard brokerage account.

#### Round 3 Accumulation

Using the same assumptions for historical annualized returns and adjusted for inflation, both the Roth IRA and Traditional IRA start at $6,500 and both appreciate over 35 years to about $61,515.

Traditional IRA:

However, the Traditional IRA investor also invested $1,430 in a standard brokerage account over the same 35-year period which appreciates to about $13,533. Before taxes, this is a huge edge for the Traditional IRA investor. Let’s see how much paying taxes will even the playing field.

After adding up the expected Social Security benefit ($27,684), Traditional IRA account ($61,515), and the standard brokerage account ($13,533), we have a total annual “income” of $102,732 before tax.

After paying long-term capital gains tax on the standard brokerage gains and regular income tax on the Social Security and Traditional IRA withdrawals, we get an after-tax “income” of about $89,950.

Roth IRA:

Now let’s compare this to the Roth. The Roth IRA investor also has an expected Social Security benefit of $27,684 and an IRA balance of $61,515 which comes out to about $89,200 in available annual spending.

After only paying taxes on the social security benefit, the after-tax available spending is $88,230.

#### Round 3 Conclusion

Once again, the Traditional IRA wins out – this time with a more narrow margin.

The key feature that allows the Traditional IRA to win is the 22% tax bracket. Taking advantage of an immediate 22% boost to your investments is just too much for the Roth IRA to overcome.

The Roth IRA only comes out on top when you are investing money from the 12% tax bracket or below.

This bar chart does a great job of helping you visualize which dollars are in the 22% tax bracket and which dollars are in the 12% or lower tax bracket.

Income Tax Bracket 2023

If I make $73,000 annually:

So if I were making $73,000 per year, you can see how much money here is in the 0% standard deduction bracket, how much is in the 10% tax bracket, the 12% and the top tax bracket in this situation is the 22 percent tax bracket. That’s $14,425. That is more than enough to top off a traditional IRA.

If I were in this situation, I would be putting all $6,500 into the traditional IRA to take advantage of that 22% tax bracket.

If I make $65,075 annually:

Now, if I was making $65,075, I have just enough. So in this situation, I would do the exact same thing. I have $6,500 in that top tax bracket. I would put all of it in the Traditional IRA.

If I make $62,575 annually:

Now in this situation, if I’m only making $62,575, then I would only put $4,000 into the Traditional IRA because once that $4,000 is used up, the remaining $2,500 is going to come from the 12% tax bracket.

In short, I would put $4,000 into the Traditional IRA and then I would put $2,500 into the Roth IRA.

If I make $58,575 annually:

And then if I were in this situation, making $58,575 or less, you can see that all the money that you invest would be in the 12% tax bracket or lower. So in this case, I would just put all $6,500 into a Roth IRA.

So here we have our answer: it depends (I know). And this will be the answer to almost any investing question. The best course of action will depend on your specific situation.

Until next time!