Why a Roth IRA?

[Guest Wolfpac]

Everytime we use a Roth IRA Calculator on the internet, it shows that we would not benefit from a Roth, we should go with a Traditional. We don't have a 401K, is that why we should go w/ a Traditional, since it's tax deductible? Any suggestions?

[Kathy]

We would like some more information please in order to play around with some of the reasons why the calculators might be wrong. What is your age? Your tax bracket (current highest marginal tax rate)? Are you thinking of converting? How much? Can you pay the taxes on the conversion from assets outside of the traditional IRA? I think there are probably a million more questions we would need to ask - about your health, your other income, your other investments, your goals, etc... But, at least give us something to start with. I think we might all have fun with it.

[Guest Wolfpac]

Thanks for the interest in the Roth. Age 31 years old, 28% tax bracket, no other money to convert. Don't have a traditional IRA. Not involved in a 401 or 403b, just mutual funds. Took out a Roth last year, maximum $2,000 invested.

[Kathy]

Well, you seem to be a good candidate for a Roth to me. You’ve got a good long time to let the money grow with all those earnings coming out tax-free when you reach 59 ½! Do the calculators ask you whether you think you’ll be in a lower tax bracket when you retire than you are now and if so, how do you answer? One of the built in assumptions is that, if you’ll be in a lower tax bracket then than you are now, you should get your deductions now and pay the lower tax rate when you’re older. But, since my crystal ball has been on the fritz for some time now, I’m not sure what my tax bracket will be when I retire 25 years from now. I hope that my investments will do so well that, if they are taxable when withdrawn, I’ll be in the highest tax bracket!! As I’ve said on this board before, I advocate maxing out your 401(k) and then maxing out any other tax-deferred savings/investment vehicles available – why not let your money grow on a tax deferred basis until you do need it?

[John G]

Lets try and simplify your problem. If you deduct the $2000 regular IRA this year you get an immediate tax savings of $560. If you elect to go the Roth route, you pass up this immediate benefit for future tax free income. If you wait 42 years (age 73) your Roth assets will grow to $128,000 (using 10%/yr). With a Roth, no tax is owed.

Remember, you will undoubtably have made other IRA or retirement contributions and could easily surpase $1 or $2 million in your account. You can guess at a likely tax rate, but the more successful you have become the more likely the rate would be atleast the 28%. Roth wins big over the long haul because your $560 savings is left out in the taxable world and can not keep pace with the Roth tax shelter.

[Guest Lyric]

One of the problems with the many calculators to be found online is that they assume you will take the money out as a lump sum after the number of years you have specified. This is the only way they can compare "apples" to "apples".

The reality is that with a traditional IRA you would need to take minimum annual distributions at the age of 70 1/2, whereas with a Roth IRA not only do you not need to take money OUT, you can still put additional earnings IN. Since you will probably have years to live beyond the date of retirement, the Roth becomes more and more attractive as a long term proposition. Tax-free compounding!