Roth Case Study

One of the most common questions we get surrounding IRA contributions is whether they should be Roth or Traditional contributions. While everybody has different situations, it is crucial to consider your current tax liability, retirement tax liability, and balance both with your lifetime tax liability.

For the sake of this example, we are only going to consider initial contributions to IRAs. If you are interested in backdoor Roth contributions, Solo 401(k) contributions, or the Mega Backdoor Roth strategy, our team has written a full white paper:

Assumptions:
7% Annual Return
24% Tax Bracket

Note: For the Roth IRA, the total value of the account is reflected. For the Traditional IRA, the balance reported is the value of the account plus the tax savings from making pre-tax contributions.

Example 1:

Keep in mind that the benefits of a Roth are even higher, as the entire balance of the account can be withdrawn from the account tax-free in retirement, while the traditional balance withdrawals will owe taxes.

Example 2:

Example 3:

While all folks who make Roth contributions enjoy tax-free withdrawals in retirement, the effects compound the longer you contribute to a Roth account. Simply stated, the longer the Roth money is allowed to grow, the more significant the benefits.

The nature of the types of investments allowed within a self-directed account can also heavily tip the scales in favor of a Roth account. If you make a startup investment that pays off, withdrawals in retirement could be heavily taxed, while a significant investment win in a Roth account will be tax-free. For a startup or real estate investment, Roth accounts can save you a lot of money in retirement income taxes.

It is important to keep in mind that not everyone can make Roth IRA contributions, as there are income limits, which, if you make too much, disqualify you from making yearly contributions. 

However, there are more ways to fund Roth accounts than direct contributions. Our team has written the Rocket Dollar Guide to Roth Retirement Accounts, which is available for free as a PDF download.

Another essential factor to keep in mind is your expected tax bracket in retirement. Depending on your situation, the tax savings of making contributions might negate the future benefits of tax-free withdrawals. The examples above are simple, and everyone has a different situation, so it is necessary to consider all options.