Roth Vs. Traditional IRA... how did you decide if it felt like a toss-up?

[FIence!]

I am about to make my first contributions for an IRA. I assumed I would go with a Roth, but now am not so sure. We are going to be in the 15% bracket this year after various deductions. I assume we will also be in the 15% bracket when I withdraw from the fund. I am unfortunately later into my 30s already, so am starting late enough that I know the growth window is shorter. (Note: I did have a Roth in the past, but closed it out to pay my own college tuition.)

I've run through some scenarios with compound interest calculators. Unlike younger people who know their money will grow and grow and likely quadruple or quintuple, at my age my money is more likely to "only" double or triple in a reasonable case scenario by the time I start withdrawing it. SO... given that the interest could very likely be similar in amount to my contributions, and my tax rate will likely be the same, I am not sure what is best.

Should I do the Roth anyway with the hope that my money will in fact triple or grow even more, and so that there is a sliver of liquidity with the home purchase loop hole in the future? Or would it make more sense to get the tax cut now so I can, in essence, have more change in my pocket which could help fund the IRA contribution next year?

[Zaga]

I go with Roth in the 15% tax bracket, and Traditional in the 25% tax bracket.  It's just my feeling on the matter, plus the fact that taxes are historically low right now, I believe they will be higher in the future.

[FIence!]

Zaga, that's a good point about not knowing what tax rates will be like in the future. Another chip in the Roth pile for sure...

[mpbaker22]

Tax bill will likely be higher with a roth,  but the roth also has more flexibility.
Tax bill likely being higher is, of course, based on current tax rates, which are subject to change.  Also with the 'rich vs. poor' mentality, keep in mind there's always a chance tax rates go up for the rich but down for you.

Then again at the 15% the tax-bill might not be higher, and it certainly won't be much higher.

[Spork]

One other consideration:  If you are planning to do ER, your contributions (not the interest) in the Roth should be available for withdrawal for any reason after 5 years.*  You can get money out of the traditional before the magic retirement age, but it's a little more involved.



*Tax experts please correct me if I am wrong here!

[markstache]

One other consideration:  If you are planning to do ER, your contributions (not the interest) in the Roth should be available for withdrawal for any reason after 5 years.*  You can get money out of the traditional before the magic retirement age, but it's a little more involved.



*Tax experts please correct me if I am wrong here!

While I'm not an expert, for a Roth IRA the contributions are available at any time. I think you are thinking of a Roth conversion, in which a standard 401k is rolled over into a Roth IRA and taxes are paid on the money at that time. I think that has a 5 year window on it. Again, not an expert.

[FIence!]

I looked on Vanguard, and it does indeed appear that Roth *contributions* can be taken back at any time. This definitely makes a Roth more favorable for me, as at this point I am going to be sacrificing part of my emergency fund to fully fund the IRA and that made me nervous.

[mpbaker22]

A note on tapping in for traditional early withdrawals.  This won't help you if you need the money for an emergency, but it sounds like it's possible.

Convert to a Roth IRA. Roth IRAs make it easier to access your money before you reach retirement. Roth IRA withdrawals before age 59½ result in a 10 percent early withdrawal penalty only on the portion of the withdrawal that comes from earnings. And since your contributions were made with after-tax dollars, no additional income tax will be due. But you need to deposit or convert your retirement savings to a Roth IRA well in advance of when you will need it in order to avoid the penalty. "Before you take money out of your Roth IRA, you have to wait five years in order to be exempt from the penalty," says Ross Hunt, a certified financial planner and co-founder of Ross and Mary Hunt, Inc. in Murrieta, Calif. A separate five-year waiting period applies to each Roth IRA conversion and rollover.

http://money.usnews.com/money/retirement/articles/2011/10/03/10-ways-to-tap-your-ira-early-without-penalty?page=2

[fiveoh]

I've done a mix of both(also in the 15% bracket) but this year mostly traditional. 

Reasons:

1. Plan to make less when retired
2. Psychological boost from higher current savings/return(i.e. I can invest 15% more now)
3. I don't trust the government to not find a way to tax the Roth in the future

[FIence!]

I've done a mix of both(also in the 15% bracket) but this year mostly traditional. 

When you do this, do you have to keep within the 5,500 limit across both combined (i.e. can put $2750 in Roth and $2750 in trad.) or can you put $5500 in each? I'm assuming combined, since otherwise everyone would just put $11,000 in two different funds every year...

[GreenGuava]

I looked on Vanguard, and it does indeed appear that Roth *contributions* can be taken back at any time. This definitely makes a Roth more favorable for me, as at this point I am going to be sacrificing part of my emergency fund to fully fund the IRA and that made me nervous.

As well it should.  May I suggest not exposing your emergency fund to market risk?

Instead, hold off until March on taking money from your emergency fund for the Roth IRA.  Then, if it looks in March like you won't max out the Roth IRA for 2013, put the full amount in - but keep some in a money market fund.  As you gradually refill your emergency fund, go to the Roth and exchange some money market for your investment assets. 

If you need the emergency dollars, it's no worse this way than if you didn't, but if you don't, it gives you more tax-advantaged space.

[fiveoh]

I've done a mix of both(also in the 15% bracket) but this year mostly traditional. 

When you do this, do you have to keep within the 5,500 limit across both combined (i.e. can put $2750 in Roth and $2750 in trad.) or can you put $5500 in each? I'm assuming combined, since otherwise everyone would just put $11,000 in two different funds every year...

Yes it is $5500 between both.