With traditional accounts, contributions are deducted from taxable income in the year you invest in your account. So if you’re in the 22% tax bracket, you’d save up to $220 on your tax bill for each $1,000 invested in one.
With Roth accounts, you don’t get to deduct contributions. You save nothing on each investment in the year it’s made. But you benefit from tax-free withdrawals. If you expect your tax rate to fall to 20% as a retiree, you’d save up to $200 for each $1,000 withdrawn. This is less than the $220 in savings a traditional account could offer, so you’d be better off with the up-front savings.
The only problem: The assumption that your tax rate will fall could very well be wrong.
Why you can’t count on your tax rate going down
There are a few big problems with assuming you’ll automatically be in a lower tax bracket as a retiree.
First and foremost, many people think they’ll end up in a lower tax bracket because their income will be lower in retirement. But this isn’t necessarily the case. Many retirees spend as much, or more, than they did before leaving the workforce. If your taxable income in retirement is close to the same as it was while working, you can’t assume you’ll be in a lower tax bracket later.