What are you going to do with your IRA in retirement?

Editor's Note: Whether to switch to a Roth IRA, however, is a personal decision that must be made on a case-by-case basis. What follows are two columns discussing both the advantages and pitfalls of the Roth IRA. 

We've all been sold on the fact that a Roth IRA is better for us than a Traditional IRA. Since the creation of the Roth in 1998, financial professional after financial professional has touted the great Roth benefit of tax free withdrawals (including growth) at retirement.

So, it makes sense that paying zero tax on withdrawals at retirement is better than paying income tax on withdrawals, right?

Let's compare. Let's assume you have $200 per month to invest for retirement from age 35 to age 65. Growing at an average of 10 percent per year in a Roth IRA your account would be worth roughly $456,000. If you invest in a Traditional IRA, you also get a tax break on your contributions that you don't receive in the Roth. So, $200 per month in a Roth is comparable to $256 per month in a Traditional IRA (assuming a 28 percent tax bracket). Investing $256 per month in a Traditional IRA gives you an account balance worth roughly $583,000 at age 65.

But, since you got the tax break up front, you now have to pay income tax on that entire balance when you pull it out. So, paying 28 percent in taxes leaves you with an account balance of only $419,000. A Roth IRA is better, right? In this example, a Roth wins by $37,000!

It is for this reason that conventional thinking says saving in a Roth IRA is better. But, is it really better to give up the tax deduction up front for the tax break you will get in retirement?

Using our numbers from above, at age 65 you'd have a Roth IRA account balance of $456,000 with no tax due or a Traditional IRA account balance of $583,000 with income tax due. If this was the end, a Roth would win after factoring in taxes. But it's not the end! Your money will keep working long after you retire. What are you going to do with your IRA in retirement, not at retirement?

Having worked with hundreds of financial situations, I can tell you from experience that IRA money is generally used last in retirement. This is usually a safety net that, if not used, will then be passed on to heirs. If that is the case, then you will never receive the great benefit of tax free withdrawals from a Roth!

If you will spend down your IRA money in retirement, it is not in one big lump sum causing that big tax hit at age 65. You will most likely take a systematic withdrawal for the amount that you need to supplement your other retirement income each month.

For example, let's assume you need $500 per month from your IRA to supplement your retirement income. To net $500 per month out of your Roth, you take $500 per month. Remember, there are no taxes on Roth withdrawals so what you pull out is what you net.

However, to net $500 out of your Traditional IRA, you would need to pull $640 per month to allow for taxes if you are still in the 28 percent tax bracket. Since your money continues to grow after you retire, your Roth balance of $456,000 at age 65 would grow to just over $1.82 million 15 years later ... even after pulling out $500 per month to supplement your income the entire time! However, your Traditional IRA balance of $583,000 will grow to just over $2.33 million over that same time ... even after pulling out $640 per month for income the entire time!

As always you should consult a financial advisor before making any changes to your current financial situation.

For additional questions or to find out what to do if you have a Roth IRA, you can contact Christopher Ordway and San Tan Financial at 480-776-1699 or visit us at www.santanfinancial.com.