Roth or Trad IRA?

My 21 year old son is a college senior. He will make $4,000 this summer and has gotten it in his head that he wants to start a IRA. He has no immediate need for the money, so he could do that. It seems silly to me, but I sure don't want to discourage him from saving money.

My issue is whether it should be a Roth or a traditional. I ran both through H&R Block software and found that if he invested the entire $4000 he would save $600 in federal and NYS tax with a trad. (he has some investment income, but his tax mainly comes from kiddie tax; which I pay on the theory that is really my tax). 15% is low, but its not that low.

Any compelling reasons to go one way or the other?

Reply to
Troubled
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You are making one common mistake when you say he will "save" tax with a Trad. IRA. He's not saving any tax, he's simply deferring it.

The simplest rule is, if you think your tax rate will be lower in retirement than now, use Trad. IRA (so that you are deferring income that will be taxed lower). If you think your rate will be the same or higher in retirement, then go with Roth.

Given his age, I'd overwhelmingly recommend the Roth, primarily because if he needs to, he can always take out his contributions at any time without tax or penalty. And if he doesn't, he has many decades of tax-free growth ahead.

However, if he does the Trad. IRA instead, I'd encourage him to save and invest the tax "savings" too.

Reply to
Mark Bole

The simple answer is yes, clearly, Roth if your tax bracket will be higher later, traditional if it will be lower.

His tax bracket now is apparently 15%. Unlikely it will be that low later.

A lot can change between now and when he retired, but at least now, Roth withdrawals don't show as income so they don't hurt you on things like taxability of SS benefits, Medicare Part B premiums, etc.

Just to give you an idea, my father has earned income of about $10K, SS of about $22K, and RMD's from his IRA's of about $15K. I projected his taxes for 2015 and found that he's in the effective 48.8% bracket. If you fall into the wrong income slice in retirement, your taxes can be really awful.

I can't think of a better idea than opening a retirement account when you're 21. If he can make 8% annually on the money for the next 45 years, that $4K would be worth around $125K when he retires. OK, inflation will have eaten at that, but still, that will be a pretty impressive sum for something he did when he was a kid.

If I may offer some investment advice, Fidelity has a number of Blackrock ETF's with no commission. For example, ITOT is a total market index fund, IJS is small cap value index. There are other providers out there will low-fee mutual funds too.

A Roth may also avoid some of the dilemma faced by another poster, who was wondering how to redomicile to Florida to reduce his state taxes in retirement.

Reply to
Hank Youngerman

First off, I wonder about the $600 tax difference you mention. As a dependent subject to the kiddie tax, your son would still get to use his earned income (up to the standard deduction amount) as a deduction on his tax return, which should make all of his summer earnings tax free.

Although I suppose that with significant unearned income, the IRA deduction could be used to offset that while still getting the increased dependent standard deduction.

But that said, I would go for the Roth IRA at this point, mainly for two reasons:

1) As Mark Bole noted, you can always withdraw your contributions without penalty, so in a pinch that money could always be used for emergencies. 2) While hard to predict tax rates 40+ years in the future, I would expect they would be higher, given that we are currently in a historically low tax rate period.
Reply to
taruss

Please use line breaks --else one can't respond in some news-readers

For ROTH money put in is taxed --- growth is not ---what's taken out is not taxed. For traditional IRA's, take out is taxed.

Reply to
Pfsszxt

If that is his only income, most likeLY won't owe any tax so trad. IRA might not be beneficial, GO ROTH GO!

Reply to
bh2os62

Clearly it's not his only income, if you read the OP.

Reply to
Mark Bole

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