Analysis released last year by the Internal Revenue Service shows younger investors are choosing Roth IRAs over the traditional variety in large numbers. Fund manager T. Rowe Price confirms that as of year-end 2013, investors under 34 have eight times more money in Roth IRAs than in traditional IRAs.
There’s logic to that, assuming young investors are looking at currently low marginal tax rates, lots of years to enjoy tax-deferred growth, and easier access to a portion of their Roth assets if a need arises a few years down the road. But as those same workers edge into higher marginal tax brackets the argument gets a little more nuanced.
The main lure of the Roth IRA is the promise of tax-free income in retirement. But is a young worker’s biggest worry the tax burden she’ll carry in retirement? Or is it the challenge of saving enough to support a comfortable retirement?
There are always plenty of competing demands for the dollars we might otherwise set aside for the future. One’s tax rate in retirement, 30-35 years down the road, can be a tenuous rationale for forgoing the deduction one might capture with a traditional IRA contribution today. After all, that deduction lowers the out-of-pocket cost of the IRA contribution which facilitates more savings. And that’s a certainty now rather than a possibility in the distant future.
Even if a young investor has the funds to maximize an IRA contribution – Roth or traditional – there are other tax-deferred vehicles in which to invest the tax savings from a traditional IRA contribution. And that brings us to one of the most basic financial planning precepts: Try to control as much capital as you can for as long as you can. Paying income taxes at a high rate in one’s golden years generally indicates that it all worked out reasonably well.
Nevertheless, popularity of the Roth IRA is widespread. According to the Employee Benefit Research Institute, Roth balances grew twice as fast as traditional IRA balances between 2010 and 2012. It looks like a lot of people would just as soon pay taxes today for the promise of avoiding them someday.