Roth or traditional: two jars, one tax bill

Most arguments about Roth versus traditional are really arguments about the future wearing a disguise. Once you see that, the whole thing gets calmer, and shorter.

Two jars

Traditional: you put in $1,000. Your taxable income for the year goes down by $1,000, so you pay less tax now. You pay tax on the money later, when you take it out.

Roth: to put $1,000 in, you first pay tax on it, about $282 at a 22 percent rate. So it takes about $1,282 of your pay to get $1,000 into the jar. After that you never pay tax on it again, including everything it grows into.

That is the whole difference. Same money, same growth, one tax bill. Traditional pays it at the end. Roth pays it at the start. Which is cheaper depends on whether your tax rate is higher now or later, and nobody knows the later one for sure.

Where the 22 percent comes from

Income is taxed in layers. The first slice of what you earn is taxed at a low rate, the next slice higher, and so on up. The rate on your top slice is called your marginal rate, and it is the one that matters for this choice, because money going into a traditional jar comes off the top slice, and money going into a Roth was taxed at it. Find yours on this year's federal bracket table, or on the top rate of your last return, and add your state's rate if it taxes income. The 22 percent in this guide is an example, not a fact about you.

The rules, plainly

With a traditional IRA you may get to subtract what you put in from this year's taxable income, depending on how much you earn and whether you have a plan at work. The money grows without being taxed each year. When you take it out in retirement, it is taxed like a paycheck. With a Roth IRA there is no deduction now; you put in money that has already been taxed. Grow it as long as you like, and in retirement you take it out and owe nothing.

Both share one yearly limit on what you can put in, set by the IRS and nudged up most years, with a little extra allowed for people 50 and older. Roth contributions are not allowed above certain incomes. Traditional deductions shrink above certain incomes if a workplace plan covers you. Those numbers move, so treat any figure you read elsewhere as last year's.

Getting at the money

Roth contributions, the money you put in but not what it earned, can usually be taken back at any time without tax or penalty, because they were taxed already. The earnings have waiting rules. Traditional money taken out before 59 and a half is generally taxed and hit with a 10 percent penalty on top, with a list of exceptions on the IRS page. Neither jar is meant to be a rainy day fund, but they do not behave the same when the rain comes.

Where the tidy version goes wrong

"Roth is always better because it grows tax free" forgets that you paid the tax up front. "Traditional is always better because you get the deduction" forgets the bill waiting at the end. The honest answer depends on your tax rate decades from now, which depends on your income then, the law then, and where you live then. Nobody knows all that. Which is why a lot of sensible people put some in each jar. Not because it is perfect. Because a wrong guess can only hurt half.

Questions worth asking yourself

What tax rate are you paying on your last dollar this year? Do you have a plan at work, and does it limit your deduction? Will you have a pension, Social Security, or rent coming in later that would fill the low tax brackets anyway? Does your state tax retirement money? And how would you feel if the rules changed on the side you picked?