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May 31, 2007


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Opt for tax-diversity--contribute to both. It seems a lot like guessing to me. Factor in that long-term capital gains (taxable) rates are low, low too, and the picture is even muddier.

I agree with the tax diversity. I asked a CPA on this one as well and I felt that his answer was very good. He said he had worked back in the 1970's when the marginal tax rate was 70% and everyone thought it was going up. If Roths had existed then high income people would have been screwed even though they were listening to sound advice. He mentioned that a bird in the hand is better than two in the bush, basically take the tax break now instead of trying to game the system, because congress could very well repeal Roth tax free status later anyway.
With that being said, I am just starting my career so I want to take advantage of this. My company offers a Roth 401k, but our match is a normal 401k match. This is perfect for me, because it basically splits me between the two theories effortlessly.

Two things - I don't think there's much question that if you're asking this question, (1)you're saving for retirement and will therefore likely have at least decent assets and income at retirement and (2)tax rates have nowhere to go but up. The U.S. has unfunded liabilities estimated between $50 trillion and $80 trillion. That's money that someone's going to have to taxes.

Second, tax diversification is an important planning tool many people overlook. Diversification isn't only for your asset classes.

Its a complicated calculation, but I'll add my info.

I earn X and want to have retirement income of about 81% of X. I think this is pretty typical. But, I have 2 kids, full 401k contributions, and about $7k a year in mortgage interest.

So, my current taxable income is quite a bit less than it will be in retirement. That, and the fact that I am concerned about tax rates increasing, I'm getting as much of my savings ROTH-ified as I can.

I agree with the first comment and the last line in FMF's post. Invest in both to hedge against what a future congress will do. Although uncommon, congress has passed laws that *retroactively* change tax rules (upping the age of the kiddie tax from 14 to 18 comes to mind); so tax planning where you don't reap the benefits decades later carries some risk. Investing in the trad IRA gives you an immediate benefit that you can turn around and invest in the Roth correct?

In my situation, my spouse is a homemaker and we're in the middle of the 28% bracket. Investing up to the max deduction in trad IRA ($4000 for 2006) gave us an extra $1000+ (from the tax deduction) to invest in a Roth.

Phil, that's a great strategy!

If you are in a tax bracket below 25%, you most certainly will be in a higher one in retirement or you won't retire at all. If you are above 28%, you will very likely be in a lower one in retirement or have so much money you shouldn't worry about taxes. If you can estimate what your expenses will be in retirement, you can estimate whether that is likely to be a higher or lower bracket. If you will be out of debt and own your home, it will likely be lower or you really are saving too much for retirement. If your expenses will continue to rise with or faster than inflation and your deductions go away, it will likely be higher.

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