Commonsense Financial Planning, The Roth Debate

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Common sense answers to questions on financial planning, risk management, and investing.

The Real Debate

The real debate exists for those who are eligible for both types of IRA

For someone who can make contributions to either type of IRA, the debate is a little more complex. However, if you do the math, you'll find that it is actually quite simple. If the taxpayer anticipates being in a higher tax bracket at retirement than they are in now, the Roth IRA makes more sense. If they anticipate being in a lower tax bracket at retirement, the deductible IRA makes more sense, provided the tax savings from the deductible IRA is invested.(something that generally doesn't happen.)

Of course, the difficulty is that individuals have long been told that they will be in a lower tax bracket at retirement. However, actual taxes paid, in real dollars, have historically risen. There are several compelling reasons that suggest that investors will be in a higher tax bracket at retirement, including:

Many deductions have disappeared for tax filers by the time they typically retire, including their house and children. These lost deductions may offset any reductions in gross income.
Over the years, tax rates have come down. However, deductions have been eliminated. For many people, this has actually increased their tax burden.
Though many individuals anticipate needing only 80% of income at retirement, they fail to consider that they may very well be improving their lifestyle over the next several years. For a professional moving up the corporate ladder, their lifestyle could change dramatically. Thus, 80% of a retiree's last working year salary may very well be twice what they were making at age 40.
A deductible IRA will increase AGI at retirement. A Roth IRA will not effect AGI. For a retiree collecting a pension, the distributions from a deductible IRA may push them into a higher tax bracket. In addition, for anyone over 70 1/2, mandatory withdrawals from a deductible IRA can be quite high. There are not mandatory withdrawals from a Roth IRA.

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