Comparing a Traditional IRA and a Roth IRA: Theory Versus Practice

Authors

  • Saul W. Adelman,

    1. Saul W. Adelman is an Associate Professor in the Department of Finance, Miami University; phone: (513) 529-1578; fax: (513) 529-8598; e-mail: adelmasw@muohio.edu. Mark L. Cross is Ohio Casualty Professor of Insurance in the Department of Finance, Miami University; phone: (513) 529-1578; fax: (513) 529-8598; e-mail: crossml@muohio.edu. This article was subject to double-blind peer review.
    Search for more papers by this author
  • Mark L. Cross

    1. Saul W. Adelman is an Associate Professor in the Department of Finance, Miami University; phone: (513) 529-1578; fax: (513) 529-8598; e-mail: adelmasw@muohio.edu. Mark L. Cross is Ohio Casualty Professor of Insurance in the Department of Finance, Miami University; phone: (513) 529-1578; fax: (513) 529-8598; e-mail: crossml@muohio.edu. This article was subject to double-blind peer review.
    Search for more papers by this author

Abstract

Financial planners often advise their clients to first take advantage of employer-sponsored 401(k) plans, especially those with matching employer contributions. They often recommend next that clients consider a traditional or Roth IRA, depending on their current eligibility and tax bracket. Generally, the traditional IRA tends to be preferable to the Roth IRA if one expects to be in a lower tax bracket during the retirement versus the contribution years. This preference could be impacted by the theoretical or the practical assumptions one could make as to the tax bracket effect, minimum distribution requirements, and the impact of withdrawals on the amount of Social Security benefits taxed. This research compares the traditional and the Roth IRA, examining both the theoretical and practical assumptions of client behavior. The results indicate that the best choice between the types of IRAs depends on whether the investor's actual behavior is consistent with theory or practice.

Ancillary