Anqi Chen, assistant director of savings research at Center for Retirement Research, Boston College, Chestnut Hill, Massachusetts. She is coauthor of the new study “How Much Taxes Will Retirees Owe on Their Retirement Income?” CRR.bc.edu
Traditional IRAs commonly allow pretax contributions and tax your withdrawals, while Roth contributions are made with after-tax dollars and all withdrawals are tax-free. As tempting as tax-free withdrawals are, most people benefit more from taking the tax break up front with a traditional IRA during their working years. Reason: Four-fifths of retired households grouped by annual income pay an effective tax rate of 0% or nearly zero. So who should have Roth IRAs?
People with large nest eggs and who expect high annual incomes. Serious tax liabilities arise only for the top fifth of retired households by income that paid an average effective tax rate of 11% on federal and state income taxes (23% for the top 1%). Effective tax rates (based on taxable income after the standard deduction or itemized deductions are taken out) are generally much lower than your marginal rate (the highest tax bracket and rate that applies to your annual income).
People who plan to leave their Roth as an inheritance. There are no required minimum distributions with a Roth, so investments can grow untouched for many years. After your death, all distributions taken by your beneficiaries typically are tax-free but must be taken over set periods to avoid a 50% penalty.
People with a large part of retirement savings in traditional IRAs and 401(k)s and who are seeking more tax flexibility as a retiree. Example: If you have both types of IRAs, you can tap the Roth in years in which you need more income but are close to triggering Social Security taxes, since Roth distributions aren’t counted as part of your taxable income.