Why Retirement Savings in Roth IRAs Tend to Outlast Traditional 401(k)s
Having enough money to last through retirement is a goal for most people, but what's the best strategy for saving? As it turns out, the type of retirement account you select can influence how far your money will take you.
A new report from the American Accounting Association explores whether it's better to pay taxes on retirement accounts when the money is invested or later, at the time of withdrawal. Specifically, it compares how retirees' savings lasts for people who have tax-deferred accounts like 401(k)s versus those with currently-taxed accounts such as Roth IRAs. The findings may come as a surprise.
Roth IRA vs. 401(k)
Overall, the research indicates that paying taxes on retirement accounts upfront will help retirees stretch their money longer than those who pay later. Currently-taxed accounts like Roth IRAs tend to outlast tax-deferred accounts like 401(k)s with similar balances, the report finds.
The researchers monitored about 350 participants who managed either a deferred-tax account or a currently-taxed account with equal balances. The money in a deferred-tax account — like a 401(k) or traditional IRA — is not taxed until it is withdrawn. The money in a currently-taxed account — like a Roth IRA or Roth 401(k) — is taxed when it is invested, rather than when withdrawn.
What the researchers found is that participants spent money at similar rates regardless of their type of account. As a result, those using deferred-tax accounts tended to exhaust their savings more quickly than those using currently-taxed accounts.
These findings help to illustrate a key difference between two different types of retirement accounts, and show how the choice in account you make could influence how long your money lasts. One way to think of this is by considering a deferred-tax account as one with "fees" — the taxes paid on withdrawal. The problem is that deferred-tax account holders may not factor in how much they'll wind up paying in these fees, so they're prone to running out of money more quickly.
"Our findings suggest people with deferred accounts may need to save more than they think, unless they're confident in their ability to account for taxes when making spending decisions in retirement," said Marcus Doxey, an associate professor of accounting at the University of Alabama and co-author of the report.
The gist is that it appears safer and easier to manage your retirement money if it's in a currently-taxed account. Paying those taxes upfront may be painful, but it's better than running out of money too soon.
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