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Roth IRA Calculator: Which Type Of IRA Should You Choose?

It's a common question: "Should I use a Roth IRA rather than a traditional IRA?" A similar question is, "Should I transfer money from a traditional IRA to a Roth IRA?"

Roth IRA Vs. Traditional IRA

Let's first lay out what makes these two types of IRAs different:

• In a traditional IRA, contributions may be tax-deductible, and all growth is tax-deferred. Tax is only paid upon withdrawal in retirement.

• In a Roth IRA, contributions are not tax-deductible, but qualified withdrawals and growth are tax free. Generally if your tax rate will be much lower in retirement than it is today, a Roth IRA does not make sense.

Factors Impacting Your Roth IRA Decision

Choosing the right IRA depends on your income, other investment accounts, your age, and most importantly your current and future tax rates. It is very important to use an accurate Roth IRA Calculator if you are actually going to make a decision this big.

Making an informed decision requires entering all of your actual account information, income, and expenses into a financial planning tool such as the WealthTrace Financial Planner

Our planning software uses the up to date federal tax code and recalculates your tax rates every year based on your changing income and tax brackets. It even takes into account tax deductions and all of your different account types. You can even figure out over how many years you should make the transfer to the Roth IRA in order to minimize taxes.

For a very quick look at how using a Roth IRA can be a benefit to you, try out our Roth IRA Calculator. The calculator is also included at the end of this article for convenience. However, this calculator is only a starting point. For a more accurate view of your situation, you want to take into account all of your income, investments, and changing tax rates using our financial planning software, which you can use for free. What is great about using your full financial plan for this decision is that you can see which years your tax rates are lowest, and choose these years for your Roth transfer.

Two Case Studies

Let's take a look at two examples of when a Roth IRA conversion makes sense and when it does not. 

Case 1: Married couple, both 45, combined taxable income of $125,00 with $100,000 in an IRA. Their taxable income in retirement will average about $75,000 per year. I assumed their rate of return would be 7% per year. They want to know if they should transfer this money to a Roth IRA and over how many years.

I first ran the analysis where they do not transfer to a Roth IRA. Here is what I found:

• Annual Expenses That Can Be Supported By Income In Retirement: $78,000
• Investment Balance At Retirement: $330,000
• Investment Value 20 Years Into Retirement: $720,000

I then ran the analysis where the transfer their IRA to a Roth IRA over a five year period, starting immediately:

• Annual Expenses That Can Be Supported By Income In Retirement: $72,000
• Investment Balance At Retirement: $250,000
• Investment Value 20 Years Into Retirement: $650,000

In this case it does not make sense to transfer to a Roth IRA. The reason is simply that their tax rate in retirement is low enough to where a transfer does not make sense. Note too that this scenario took into account the actual federal tax code, state taxes, and their changing tax rate over time.

Let's look at a second case.

Case 2: Married couple, both 45, combined taxable income of $125,00 with $0 in an IRA today. The couple is trying to decide whether to place money in an IRA today or a Roth IRA. They plan on contributing $7,000 per year for 20 years. I assumed their rate of return would be 7% per year. Their taxable income in retirement will average about $90,000 per year. 

The results are as follows:

Contribute to a Traditional IRA:

• Annual Expenses That Can Be Supported By Income In Retirement: $79,000
• Investment Balance At Retirement: $220,000
• Investment Value 20 Years Into Retirement: $714,000

Contribute to a Roth IRA:

• Annual Expenses That Can Be Supported By Income In Retirement: $88,000
• Investment Balance At Retirement: $220,000
• Investment Value 20 Years Into Retirement: $875,000

In this case, the couple is better off using a Roth IRA because their tax rate is high enough in retirement to justify paying taxes today vs. when they withdraw the money later.

No RMDs for Roth IRAs

Another nice benefit of Roth IRAs is that there are no Required Minimum Distributions (RMDs) while the owner is alive. To read more about RMDs and to use our free RMD calculator go here.

You can also have one of our financial planning experts help you with this important decision and your entire financial and retirement plan if you choose. 

 

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