What is the Best IRA, Traditional or Roth?

The question of which IRA is the best IRA for an individual investor, a Traditional or a Roth? My answer is Yes you need to get one and which one depends on a couple of things.

A Traditional IRA is different from a Roth IRA in several ways shown below:

• In general, an investor in a Traditional IRA gets an income tax deduction while a Roth IRA does not.
• In general, a Roth IRA grows tax free an no income tax is paid on any gain in the future while a Traditional IRA grows tax tree and income tax is paid on any gain in the future.

If you have sufficient resources so that you can fund the IRA limit with either a Traditional or Roth IRA the Roth wins every time. Because the growth is tax free and no income tax is paid on any gain this gives the best value for an investor.

However, if you live on a limited budget a Traditional IRA may be better than a Roth IRA. The reason is the tax savings in the current year and the tax rate when the money is needed in the future.

Example: A investor has the resources to fund a Roth IRA by $3,000 a year. If a Traditional IRA gives the investor a tax reduction of another $1,000 each year that can be invested then $4,000/year can be invested. Due to re-investing of the tax deduction 25% more money is invested with the Traditional IRA. Which is better $3,000/year Roth IRA or $4,000/year Traditional IRA invested on average 9% per year for 30 years.

In 30 years, the Traditional IRA has a value of$545,230 that is taxable income while the Roth IRA has a value of $408,923 that is income tax free. Which is better? It depends on the tax rate at the end of 30 years. If the tax rate is the same as when the original money was invested, 25% the after tax value of the Traditional IRA is $408,923, the exact same as the Roth IRA.

If the tax rate is less, which is a real possibility, the Traditional IRA is better. If the tax rate is 20% the after tax value of the Traditional IRA is $436,184. This is better than the Roth by about $25,000.

If the tax rate is higher, which is a nice problem to have, the Roth IRA is better. If the tax rate is 30% the after tax value of the Traditional IRA is $365,304. The Roth IRA is better by about $44,000.

Which is better a Traditional or Roth IRA? It depends on the availability of resources, if the tax savings that goes with the Traditional IRA is invested, and the income tax rate when money is removed from the Traditional IRA account.