UpFront | Published in May 2017

Roth Often Delivers Greater Ending Wealth

By John Manganaro | May 2017
A report from NerdWallet argues that, for most savers, at largely all income levels, utilizing a Roth individual retirement account (IRA) can generate significantly more retirement wealth compared with a traditional IRA.
Outlining the research results, Arielle O’Shea, co-author of “Roths Top Traditional IRAs by up to Six Figures in Retirement Savings Analysis,” says she and her colleagues were intrigued by just how well the Roth approach performed in the comparative analysis.
“Using a Roth individual retirement account nets investors more retirement dollars in many cases,” she observes. “The difference is well over $100,000 in the vast majority of tax scenarios.”
O’Shea, who wrote the analysis with Jonathan Todd, says she was “surprised to see such a widespread gap in performance across so many tax scenarios. That was striking.”
“No matter what your tax rate is now and what you might expect it to be in retirement, if you’re making the maximum contribution, we measure that Roth essentially always outperforms, because of the strong benefit of pre-paying your taxes,” she continues. “You don’t really think about it this way, but you are pre-paying the taxes in the Roth, so in a sense you are investing more money than you otherwise would be able to. It costs you a little more to make those contributions in the moment, of course, but you are doing your future self a huge favor in retirement by taking this approach.”
NerdWallet’s research might raise an eyebrow among IRA enthusiasts, because the conventional wisdom is that an investor should go with a traditional IRA unless he has sat down and done a serious analysis of what his individual tax rate is now and what he believes it may be in the future. But these results argue basically the opposite: The Roth approach almost always results in more ending wealth.
“I would make one caveat,” O’Shea says. “It’s important to note that we looked at maximum contributions.”
She adds, “Lower down on the contribution scale, below the maximum, things get a little muddier, certainly. But we think it’s important to highlight this as a goal for people—to represent what the ideal might be so that people can work toward that. If you are maxing out contributions, most likely it will make sense to go with Roth.”
The analysis offers some additional examples: For someone with a current effective tax rate of 20%, the cost of making a $5,000 contribution to the Roth would be $6,250. “Another way to think about this is to say the individual has saved $5,000 and, at the same time, pre-payed some of the tax he would otherwise owe in retirement,” O’Shea says. “So the trick is that this after-tax account is allowing the individual to save more on net than he could in a traditional IRA, through which you aren’t able to pre-pay taxes.”