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UltraVires
02-14-2010, 10:40 AM
I know I should contact a professional for tax advice, but this questions seems straightforward enough.

If I only use the standard deduction (because the other deductions including IRA contributions) don't equal that amount, then it would be silly not to contribute to a Roth vs. Traditional IRA, no?

Because I am not taking advantage of the tax free contribution status now, and would be able to take advantage of it when I retire?

Thanks in advance.

Tim R. Mortiss
02-14-2010, 10:59 AM
IANATL, so I might be wrong, but I think you can deduct an IRA contribution even if you don't itemize deductions.

In that case, your decision should be based on whether you think your tax rate will be higher or lower when you retire. On the one hand, you'll probably be earning less money per year. On the other hand, tax rates tend to increase over time. So it's a crap-shoot.......TRM

IAmNotSpartacus
02-14-2010, 11:12 AM
, then it would be silly not to contribute to a Roth vs. Traditional IRA, no?

In almost all instances it's silly not to put money into the Roth versus the traditional IRA. Basically, you pay taxes on your principal with a Roth. With a traditional, you pay taxes on the principal and the capital gains. No worries about capital gains with a Roth.

Bill Door
02-14-2010, 11:48 AM
It depends on your age. For young people in a low tax bracket with many years to accumulate gains the Roth is a better deal. If you're older and in a high tax bracket the benefit of the immediate deduction outweighs the tax free gains.

drpepper
02-14-2010, 06:35 PM
Leaving aside for the moment the relative advantages and disadvantages of Roth v. Traditional, Tim is correct.

Your traditional IRA contribution is deducted as an "adjustment" to your income, and has nothing whatsoever to do with itemized vs. standard deductions.... it is a completely separate part of the tax return.

Bobalude
02-14-2010, 07:55 PM
Be sure to check that you are eligible to take the Traditional IRA deduction if you decide to go that route:

http://www.irs.gov/retirement/participant/article/0,,id=188232,00.html

Bytegeist
02-14-2010, 10:32 PM
In almost all instances it's silly not to put money into the Roth versus the traditional IRA. Basically, you pay taxes on your principal with a Roth. With a traditional, you pay taxes on the principal and the capital gains. No worries about capital gains with a Roth.

On the other hand, let's suppose I die of old age about halfway through the spending of my nest egg, after retirement. With a Roth IRA, I will have paid income taxes up front on a lot of money that I'll never get to spend. With a traditional IRA, those taxes will have been deferred, so I'll have a larger income during my younger days — which I can either spend, or invest in other kinds of funds that have a quicker payoff. A payoff I'm more likely to benefit from while I'm alive.

I am not a financial whiz by any consideration, so I welcome criticism of this analysis. (I have friends and relatives who keep trying to convince me a Roth IRA is inarguably better than a traditional one. To me it seems like it's just a different kind of gamble.)

Note: apologies for the slight hijack. I realize this isn't quite what the OP is asking about.

dracoi
02-15-2010, 11:12 AM
Bytegeist, the reasons you cite are exactly why the OP should talk to a financial planner. (Not just a tax person - the real issue is planning for retirement and diversifying your assets, since "taxable" vs "tax free" is a consideration).

This is a really important consideration. For example, Social Security income is not taxable if you make less than about $25,000 in taxable income. So if you want $60,000 a year during retirement, here are two scenarios:

Scenario 1: No Roth
$12,000 Social Security
$48,000 Traditional IRA distribution.
Adjusted Gross Income: $54,000. (I'm simplifying)
Taxable Income: $40,000 (still simplifying)
Tax due: $4,000

Scenario 2: 50% Roth
$12,000 Social Security
$24,000 Traditional IRA
$24,000 Roth IRA
Adjusted Gross Income: $24,000 (SSA and Roth not taxable!)
Taxable Income: $10,000
Tax due: $600.

So there are a lot of issues that need to be considered.

IAmNotSpartacus
02-15-2010, 11:20 AM
I am not a financial whiz by any consideration, so I welcome criticism of this analysis. (I have friends and relatives who keep trying to convince me a Roth IRA is inarguably better than a traditional one. To me it seems like it's just a different kind of gamble.)

Absolutely and there are definitely going to be times where the traditional IRA will be more beneficial than the Roth... but those times are not common.

Rumor_Watkins
02-15-2010, 11:22 AM
Echoing what has been already said:

Traditional IRAs are better if your current income is in a higher tax bracket than what you anticipate your retirement income to be - they can be used to effectively reduce a tax burden by prolonging it to a future time when your tax rates are lower and the time value of that money is lower (i.e. $10 in tax today is more than $10 in tax tomorrow). Of course, if tax rates go up in the future, this benefit is somewhat reduced

Roth IRAs are better if you have low income now and you anticipate having a higher tax rate upon retirement - basically, for low income earners.


edit: oh, also. if you live in a state with a state income tax now and anticipate retiring to a state with no income tax later, Roth IRAs are going to cost you the state income tax that you paid now but will never recoup when you retire.

Mama Zappa
02-15-2010, 12:13 PM
In almost all instances it's silly not to put money into the Roth versus the traditional IRA. Basically, you pay taxes on your principal with a Roth. With a traditional, you pay taxes on the principal and the capital gains. No worries about capital gains with a Roth.
I would agree.

You have to look at your own tax situation, for sure.

Right now we're putting more toward regular 401(k) vs. Roth 401(k) because we need to reduce our taxable income (as it causes phaseouts of deductions etc.). We do put *some* in the Roth 401(k), of course, it's just not the bulk of our deductions.

Roth IRAs become unavailable if your income is high enough, also, in which case you'd need to put the money into a non-deductible IRA. As I understand it, there's presently a loophole where you can recharactize that money into a Roth, regardless of income.

And Tim R. Mortiss is correct that a deductible IRA is completely independent of whether you itemize deductions or not - completely different section of the forms etc.

Bobalude
02-15-2010, 12:22 PM
Absolutely and there are definitely going to be times where the traditional IRA will be more beneficial than the Roth... but those times are not common.

That is a big generalization. dracoi is right that there are many many situations out there and each person's needs are different.

One point that people should remember is the option to process a conversion from a Traditional to a Roth IRA at will. Besides planning far out to retirement to decide to use a Roth or a Traditional IRA (or 401k/other retirement plan), unexpected things may happen where using conversion may make sense if you had pre-tax dollars saved and available.

Someone (or a spouse) may lose a job or stay home to raise a family, and the tax bracket will drop significantly for a year (or more). Or one may decide to go back to school full time and have no income for a year or two.

Also, in the unfortunate event your IRA investment drops in value below your contribution amount (like last 2 years)... if you had a traditional IRA, you could convert and pay taxes on the now lower value of the IRA for an overall lower net tax liability (compared to paying taxes on the full contribution amount to make the Roth contribution) to have effectively same amount in your Roth IRA.

Having the ability to choose when to convert money and pay those taxes just opens more financial planning options. My opinion is that most people in the middle tax brackets should consider having a little of both pre-tax and Roth savings for flexibility.

IAmNotSpartacus
02-15-2010, 04:21 PM
That is a big generalization.
Correct. What else did you expect? Free tax advice and retirement planning on an internet message board? :confused: You get what you pay for, as always.

More points to consider that have not been raised.

Traditional IRAs have mandatory distributions, Roth IRAs do not. At age 70 1/2 you have no choice but to take distributions from the traditional IRA.

Contributions to a Roth can be withdrawn at any time, penalty and tax-free. Withdrawals from a traditional IRA will incur a 10% penalty and be taxed at the highest current rate (unless qualified under a penalty-free exemption from the IRS).

Roth contributions are limited by income, if you make too much then you can't contribute to a Roth. But frankly, I would expect anyone pulling down more than $105k as a single earner or $167k filing jointly would have long ago had this discussion with their financial professional.

UltraVires
02-16-2010, 09:06 PM
IANATL, so I might be wrong, but I think you can deduct an IRA contribution even if you don't itemize deductions.


I did not know that. I know it now. Thanks to you and the other posters who put an extra $575 in my pocket this tax season. I wasn't even going to claim that money because I thought it was a regular deduction. Many thanks.

Angel of the Lord
02-17-2010, 04:19 PM
Contributions to a Roth can be withdrawn at any time, penalty and tax-free. Withdrawals from a traditional IRA will incur a 10% penalty and be taxed at the highest current rate (unless qualified under a penalty-free exemption from the IRS).

Qualification (http://www.fool.com/money/allaboutiras/allaboutiras06.htm): if you go into the interest, you're going to be taxed with that same 10% tax penalty unless you have one of the IRS-approved reasons. It's a small point, and I know that's what IAmNotSpartacus meant, but it's that kind of thing that can trip people up.

iamthewalrus(:3=
02-18-2010, 05:24 PM
On the other hand, let's suppose I die of old age about halfway through the spending of my nest egg, after retirement. With a Roth IRA, I will have paid income taxes up front on a lot of money that I'll never get to spend. With a traditional IRA, those taxes will have been deferred, so I'll have a larger income during my younger days which I can either spend, or invest in other kinds of funds that have a quicker payoff. A payoff I'm more likely to benefit from while I'm alive.This is, essentially, an argument for saving less.

However much money you have left when you die is wasted in this analysis, because you could have spent it doing fun things while you were alive. Of course, since you (usually) don't know when you'll die, it's tough to maximize your expenditures and not run out of money.

Now, if your only choices were to put $x into a Roth IRA or $x into a traditional IRA, and you were worried about saving too much, then the traditional IRA is a better choice. It will leave you more money now, and less money (effectively, after tax) when you die. However, you can equalize this by simply putting less money into a Roth IRA now. Comparing the two options at your later death, you won't have the same dollar amount in the two plans, but you could easily have the same effective after tax amount.

A complementary way to think about the decision is that a Roth IRA effectively lets you save more, now, because the contribution limits are the same. Because you're paying taxes now, rather than later, it's like saving an extra whatever-your-marginal-tax-rate-is percent over the limit with a traditional. That assumes that your tax rate will never change, which is not a very safe assumption, but I'm not convinced that there is a better one.

DaveRaver
02-18-2010, 06:38 PM
Wouldn't a traditional IRA be better since you'll be paying taxes after you retire, when you'll be in a much lower tax bracket?

iamthewalrus(:3=
02-19-2010, 07:32 PM
Wouldn't a traditional IRA be better since you'll be paying taxes after you retire, when you'll be in a much lower tax bracket?You're assuming that you'll be in a lower tax bracket when you retire, which is not a given. Judging by the past, it's not a terrible assumption, but predicting both your future income and future tax brackets is pretty difficult.

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