Roth vs. Traditional

In another thread, there was a discussion of Roth vs. Traditional IRA's. I thought it was worth starting a new thread solely for this topic, without getting into the question of conversions.

If you are always going to be in the same tax bracket, there is no difference between the two. However, that is unlikely.

So what are the considerations?

1) If you will have to take the money prematurely, you can withdraw the principal (but not earnings) from a Roth after 5 years with no penalty. 2) There are no minimum distributions from a Roth. So if you anticipate not needing the funds by age 70 1/2, a Roth is superior. 3) I'm not sure about this, but both types of accounts are treated the same for estate tax purposes. (Remember, there are still state estate taxes, it's not only Federal.) If you have a smaller Roth rather than a larger traditional, only the smaller post-tax balance is subject to estate tax. 4) If you anticipate retiring to a state with a lower (or no) income tax, this favors the traditional, as it implies your tax braket will be lower in retirement. 5) This for me is the biggie - Traditional withdrawals are income on your 1040. This means that it can make your social security taxable, and cause your Medicare Part B premiums to be higher. I think there will be more and more cases where the government will try to restrict various forms of benefits for higher-income retirees. If your money is in a Roth, you will "look" poor when you file your 1040. 6) Is there really anywhere for tax rates to go at this point but up? 7) Should income tax rates be reduced and the revenue replaced by some kind of consumption tax, the consumption tax will not affect your retirement balance, but it would imply lower income tax rates later.

The bottom line for most taxpayers/investors is that you should put your money in a Roth if you expect to be in a higher tax bracket in retirement than you are now, and a traditional if you expect to be in a lower bracket. It will depend a lot on your own situation and on your expectation of future tax laws. Nothing would prevent the IRS from treating Roth withdrawals as income for some of the purposes listed.

However, when considering your future tax bracket, you should consider item #5. If your income excluding IRA withdrawals will be so high that you will pay the maximum tax on social security and maximum Part B premiums anyway, then it doesn't matter. If your income including IRA withdrawals will be so low that you won't be paying any or much tax on social security, again this is not a consideration. However, I suspect that most readers of this group lie somewhere in that middle ground.

Finally, note that Roth deferrals are in effect higher. If you are maxing out your retirement contributions already, you can effectively defer more in a Roth. I will not offer the full mathematical proof, but if you are in the 25% bracket, then deferring $15000 in a Roth is mathematically identical to deferring $20000 in a traditional. Of, if you prefer, deferring $16,500 in a Roth 401(k) is the equivalent of deferring $22,000 in a traditional 401(k). You can, in effect, defer more in a Roth.

Reply to
Hank Youngerman
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Agreed. One should have a proper emergency fund, but you are correct.

No one said you must spend the money. I don't see the advantage. You trade flexibility, but at the cost of having paid tax already.

Income with Respect of a Decedent kind of negates this. But in general estate taxes impact a small slice at the top, not the majority.

Agreed.

Agreed. To a point. The taxing of social security creates some nasty phantom rates, but once fully taxed, the taxpayer is back to 'regular' marginal rates. Figuring out where this bubble occurs is the trick. For most who feel they'll save their way to a higher bracket, they'll be well beyond that phantom rate bubble. For those right in it, a series of conversions right after retirement but before drawing Social Security is the solution.

Yes. Zero. However unlikely, a value added tax and consumption tax can replace our income tax system. That would hurt Roth holders.

Right, but the Roth holder has already trimmed his balance by X%.

All your points are well taken, esp #5. My concern is that the average person has so little saved by retirement that they land in the 10/15% bracket, and can convert then to "fill" the bracket, but no more. I have an 80yr old woman, was in 25% bracket while working. For the past few years we've topped off her 15% rate, and will keep doing that. Just one example.

Reply to
JoeTaxpayer

You can withdraw contributions (not conversions, not earnings) from a Roth IRA at any time with no tax and no penalty.

-Mark Bole

Reply to
Mark Bole

Additionally, when passing a Roth to beneficiaries at death, it continues as a Roth with all the benefits, whereas distributions are forced upon the beneficiaries of the Traditional regardless of their age if the decedent has begun RMD's. Deferral is a large benefit once it passes to a younger generation.

Reply to
Tyler Franks

An inherited Roth has the same withdrawal requirement as an inherited traditional IRA. The lack of RMDs doesn't extend to the next generation (or non spouse, for that matter).

Joe

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Reply to
JoeTaxpayer

I completely misconstrued something I read. Thanks for the correction.

Reply to
Tyler Franks

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