rogernusbaum

Michael Batnick had a Tweet for a recent podcast with Ben Carlson about Roths versus traditional accounts. The simplistic difference between the two accounts is that with Roth accounts, you pay taxes on the front end (no deduction for making a contribution), your money grows tax free inside the account and there are no taxes on qualified withdrawals. For a traditional IRA/401k, you get the tax break on the way in (a deduction for making the contribution), your money grows tax free inside the account and then you owe taxes on the way out when you make a withdrawal. The other wrinkle in this equation is that with traditional accounts you are required to start taking a little bit out when you turn 72 (recently upped from 70 1/2) so that the government can collect tax from you. There are no required distributions from Roth accounts because there is no potential tax to collect.

I replied to Michael's Tweet saying "both" which then drew a couple of comments including whether further bumping the required distribution age to 75 due to increasing lifespans might make the Roth relatively less attractive than they are now. That's a good question but my overriding belief in both is mostly about my perception of optionality.

There is a school of thought that says you defer taxes as long as possible. If that resonates with you then you'd go with traditional accounts. There is a school of thought that says it is better to pay taxes on a smaller piece of money now instead of a larger piece of money in the future. If that resonates with you then you'd go with Roth accounts.

What is your tax bracket? If you're lucky enough to be able to put $10,000 into a traditional account and you're not paying $2000 or $2400 in taxes on that money, that money stays in your pocket which is at the very least, appealing. I find it just as appealing to know that money in a Roth is accessible without tax for something unexpected once I turn 59 1/2 (some of it can be accessed earlier but that is beyond our scope today).

The most important aspect of optionality in my opinion is having some money in Roth accounts to cover unexpected large purchases. I've used this example before but if you're in the 20% bracket, you are going to buy a $40,000 car, you only have a traditional IRA and like me you don't want to take on a car payment, then your $40,000 car will cost $50,000 (a little more factoring in state tax). I realize plenty of folks are willing to take on debt but I am personally motivated to avoid that. Your required minimum distribution from your traditional account is like earned income (talking mental accounting), you pay yourself and you owe tax. I find that extra expense in the car example to be onerous. I do have a couple of clients who do not rely on their RMDs to live on so they can either put that into a taxable account or use it to buy discretionary items. That is a slightly different circumstance because they have to take the money out but don't need it.

There are infinite variables here to picking what is best for yourself. As I think about what my financial situation will be when I am in my 70's, I don't foresee any unusual circumstance where my wife and I need to do something unique in our planning. For 2021 I already contributed to our HSA (following up from previous posts, we have an HSA this year) and I expect we'll contribute to retirement accounts at a ratio of 3 to 2, traditional to Roth accounts.

The value I place personally on optionality is the point that this post is getting to. I've referenced thinking about and doing things for the future you in many posts before. I believe I did quite a few things in my 20's and 30's that greatly benefitted me in my 40's and 50's. Not having to spend $50,000 on a $40,000 car is just one example where I might be helping out the future me, the 65 year old or 70 year old me. I would encourage you to also think in those terms.