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« 12 Financial Rules Made to be Broken, Rule 6 | Main | Best Money Post I've Ever Written, Part 6 »

August 28, 2005

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Where do you have your IRA? If you have one....Thanks

i disagree about the not using non-deductible IRA accounts

if you are going to have any allocation of your investments to fixed income products, or REITs, or anything not tax-advantaged, non-deductible IRAs are superior to taxable accounts, since capital gains over time will be a smaller percentage of returns than interest.

another problem is that the tax rate on capital gains when you retire is not guaranteed to be as low as it is now. it is subject to legislative fiat. i am guessing the rate will get closer to the avg income tax rate over time

A Roth IRA is better than a Traditional IRA if and only if the investor's current marginal tax rate is lower than his marginal tax rate at the time of withdrawal. If your tax rate is higher now than it will be when you make withdrawals, you should invest in a Traditional IRA.

Also, I take issue with this:

"When you make withdrawals from an IRA, your earnings will be considered ordinary income and will be taxed at a rate as high as 35%. That compares with a rate of 15% (or less) on long-term capital gains in a taxable account."

But the money you put into that taxable account has already been taxed at "a rate as high as 35%"! The money you put into a traditional IRA has not been taxed at all.

This post is full of bad advice.

FMF is right when mentioning that someone should fully fund a company sponsored plan first, but when comparing ROTH vs. Traditional, a suitable analysis for anyone weighing the option is offered up at my site. Check it out:

http://unclejacks.blogspot.com/2005/06/roth-vs-traditional-face-off.html

I've always taken issue with this common advice; as Dan said, it assumes that your marginal tax rate at retirement will be higher than your current one. This is likely, but FAR from certain. Furthermore, it assumes over a very long period (40+ years for those just starting out) that the tax system will not be changed to, say, a flat tax, or a VAT-like sales tax, or any of a number of drastic changes that would eliminate the Roth's advantage. Many analyses, as Uncle Jack points out, assume that you are investing the same amount in a Roth as in a Traditional, despite the fact that you must pay taxes on the Roth investment and thus are not really likely to invest as much there as you would in a Traditional.

AF --

I keep most of my investments at Vanguard. I've found that they have 1) great investment choices, 2) low costs, and 3) good service.

FMF

Next year there will be a new type of 401k available, a "Roth" 401k. Unlike a normal 401k, contributions will be after-tax. Unlike a Roth, there are NO INCOME LIMITS. See if you can get your employer to offer one. (Roth 401k's can be offered alongside a normal 401k. The $15,000 annual limit applied to both -- you can split this total amount between the two types of 401k however you want.)

I read through the comments but didn't see anybody mention one advantage to the Roth IRA: no required minimum distributions. If you retire with a 401(k), a pension, and Social Security, having the option to NOT take a distribution if you don't want to is nice.

Also, if you set a Roth IRA up properly, the account can be passed down upon your death and the beneficiary can stretch tax-free payments over THEIR lifetime. Even a small Roth IRA can make a huge difference in a person's life.

"I read through the comments but didn't see anybody mention one advantage to the Roth IRA: no required minimum distributions."

JLP - That's because you have to go to a financial planner's blog to see that information. I referenced it in my article.

jack

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