This blog is a way for me to share hard learned lessons about money with those who are just starting out on their own. I hope it's a way for you to avoid making the mistakes I made, and to benefit from my experiences

Sunday, January 21, 2007

Roth vs. Traditional IRA

I keep seeing everyone advocating putting money in Roth vs. a Traditional IRA. Maybe they're seeing something I'm missing. To me, a Roth is really the best choice only in a narrow set of circumstances.

For many, they did not save as early as they should of. And even if investing everything they can for retirement, their retirement will still earn them less taxable income than they earn now. So why would you want to pay the higher tax rate now and then invest in a Roth, vs. take the bigger tax break now and invest in a Traditional IRA or your 401k?

For example. Right now I'm in the 25% tax bracket. However, by every retirement calculator I've ever ran, my annual retirement income will place me in the 20% or less bracket. So why not pay lower taxes later?

The common argument against my point is that you don't know what Congress will do to tax rates in the future. Fair enough. But you also don't know what they'll do to Roth rules either. If the gov't is hard up enough that they need to raise income taxes on less affluent retired seniors, they can just easily turn around and say that Roth earnings can be taxed too.

The Roth does offer one nice feature. You can withdraw your contributions (not earnings) early, without penalty. This makes it a good way to save for retirement, but still have that cash available without penalty if another more important need arises. I have seriously considered this as an investment vehicle for my son's college education / my retirement, while putting everything I can into my company's tax-deferred 401k. If you ever look at the 529 plans, they have penalties galore if the money is not used to spend on a post-high school education. The Roth would have none, as long as I only took out my contributions, and left the earnings in for my retirement.

Unless you are predicting a rosy scenario retirement, I say take the sure thing bigger tax break now, and use that extra tax savings for further investments of one sort or another.

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