This Type of Retirement Account Is More Likely to Run Dry

One of the toughest decisions we face when saving for retirement boils down to this: traditional IRA or Roth IRA?

Many of us also have to choose between traditional and Roth when making 401(k) contributions.

In truth, there is no easy answer to the question of which approach is better. However, if you choose the traditional route, you might be at greater risk of running out of money than if you had gone with a Roth instead, according to a recent study published by the American Accounting Association.

Researchers designed an experiment in which 350 Americans all had the same amount of retirement savings.

Some of the study participants were assigned tax-deferred (traditional) retirement accounts. With these accounts, you get a tax deduction for the year of each contribution, but you have to pay taxes on the principal and growth when you withdraw from the account in retirement.

The rest of the study participants were assigned after-tax (Roth) accounts. With this type of account, you don’t get tax deductions for contributions. However, you don’t pay taxes on the principal or growth when you make withdrawals in retirement.

The first thing the study revealed was that regardless of which option savers were assigned — tradition or Roth — they spent down their money at similar rates during retirement.

That is important because withdrawals from traditional accounts are considered taxable retirement income. That is not the case for withdrawals from Roth accounts.

The upshot is that someone who takes $10,000 out of a traditional account will lose a chunk of that money to taxes. On the other hand, someone who withdraws the same amount from a Roth account can spend the full $10,000.

In a summary of the findings, Marcus Doxey — co-author of the study and also an associate professor of accounting at the University of Alabama — says:

“People are spending money on the same things, so their expenses are the same. However, [traditional IRA] users also pay tax on their savings every time they use them — which means, in practice, they’re paying an additional fee. As a result, their savings decline at a faster rate.”

Over time, folks in the study who had traditional accounts exhausted their savings faster than those with Roth accounts, the researchers found.

Shane Stinson — co-author of the study and an associate professor of accounting at the University of Alabama — said in the summary that people with traditional accounts simply did not fully account for the toll that taxes would take on their retirement savings “even when we explicitly told them about the tax consequences.”

The researchers conclude that unless savers are confident in their ability to account for taxes when spending, they might need to save more than they think for retirement if they choose the traditional route.