Which do you prefer? Roth or Traditional

[matjone]

This has been debated on here before, but I am curious to know where people stand.  I think for most people the spreadsheets tell them to pick the roth and get the tax savings later.  That is always what I believed, so I always made roth contributions foregone the tax deduction.  But after thinking it over for a while I think I've changed my mind.  The main reason is that I don't really trust our government to keep their promises, and lately I am leaning more towards guaranteed money now, vs. promised money later.

 

If you'd like to share your rationale behind your choice, that would be great, as that is what I am really looking for.  Making the wrong decision on this could make you a lot poorer in the end, so I think it's smart to consider other opinions.  Also, each individual has different circumstances, so what is right for one may not be for another.

 

Also I am not sure if people from other countries have a similar choice, but if so I'd like to hear your thoughts on the subject as well.

 

TIA

[argonaut]

Depending on how much you can set aside, max both! If you need to choose, then year by year it can vary as the folks in DC change their minds...

[ERICOPOLY]

Let's say you go with the Roth, then later get divorced before you are 59.5.

 

Your spouse could wind up getting 1/2 of it.  Then, any taxable gains (in the Roth, assuming it appreciated since the conversion) she takes from you will be taxed!

 

So beware the double taxation.

 

[TwoCitiesCapital]

The choice is obvious if you're young and single in the U.S. record debt with historically low taxes all around eventually means higher taxes. If you're younger and plan to make more as you get older,  then taxes will also go up in the future.  I choose Roth.

[CorpRaider]

If you are in a low enough bracket to qualify for the traditional, i would go with that.  You will have control over timing of recognition of the income.  Gw bush iii comes in and slashes rates?  Convert it to a roth or at least some of it.  Move to texas and convert it...people pay big money for advice on how to defer recognition of income. 

[Ross812]

You can put away 23k a year as an individual or 46k as a couple In Roth/Trad 401k + Individual Acct. We usually put enough in the traditional to knock us down a tax bracket then save everything else in the Roth accounts.

[CorpRaider]

Thats probably a good plan.  Get some "tax diversification".

[racemize]

I think there are two things to consider:

 

1) tax rate now versus tax rate later; and

2) whether you want to put more effective money (this is mostly influenced by 1)

 

If the taxes will be the same, then the answer is Roth, assuming you can put it away.  The reason for this is that the limits are the same, even though one is taxed and one isn't.

 

For example, for a 401k, the limit is 17,500 in the U.S., for both traditional and Roth.  That means you can put more money into the plan now in a Roth than the traditional, because they two numbers aren't the in the same units.  e.g.,:

 

Traditional 401k - saves 17,500 in pre-tax money, that will later be taxed.

Roth 401k - saves 17,500 after tax and won't be taxed later.  As a comparable to the traditional, it needs to be converted back out to pre-tax to see the difference.  At a 35% rate, you are saving ~27k pre-tax, which is a lot more to put into a retirement account than the traditional lets you, so you are effectively putting away more money with the Roth.

[matjone]

That's all true, racemize.  I guess I have a trust issue with the government. I think the world has decided that when people are hurting, those who have saved have responsibility to bail out those who haven't.  So I can see a day when they come after these accounts.  It has already been proposed and I have heard that other governments have double dipped into people's retirement accounts (I think it was in Australia.  If anyone has stories like this I'd like to hear them).  If it was 100% certainty that the roth would not be touched it would be less complicated. 

 

Eric brings up another good point about divorce.  I honestly didn't know that they were treated differently.  I kind of figured all assets were split up 50/50 (or maybe more like 70/30 according to some I've talked to) in a divorce.

[Ross812]

I think there are two things to consider:

 

1) tax rate now versus tax rate later; and

2) whether you want to put more effective money (this is mostly influenced by 1)

 

If the taxes will be the same, then the answer is Roth, assuming you can put it away.  The reason for this is that the limits are the same, even though one is taxed and one isn't.

 

For example, for a 401k, the limit is 17,500 in the U.S., for both traditional and Roth.  That means you can put more money into the plan now in a Roth than the traditional, because they two numbers aren't the in the same units.  e.g.,:

 

Traditional 401k - saves 17,500 in pre-tax money, that will later be taxed.

Roth 401k - saves 17,500 after tax and won't be taxed later.  As a comparable to the traditional, it needs to be converted back out to pre-tax to see the difference.  At a 35% rate, you are saving ~27k pre-tax, which is a lot more to put into a retirement account than the traditional lets you, so you are effectively putting away more money with the Roth.

 

 

If you really want to be sneaky about it. Live off of non ira savings or roth savings and roll your traditional into a roth in 36k increments. Pay 13.5% tax on the taxable conversion. After 5 years you can start withdrawing the 36k from the roth tax and penalty free. This is assuming you retire early.

 

I think the tax diversification is what you want. Unless you plan on retiring very extravagantly you should put at least enough in your traditional that your withdraws stay in a low tax bracket and everything else in the Roth.

[ERICOPOLY]

Eric brings up another good point about divorce.  I honestly didn't know that they were treated differently.  I kind of figured all assets were split up 50/50 (or maybe more like 70/30 according to some I've talked to) in a divorce.

 

 

So if I have a 10m Roth IRA with a cost basis of 300k, she would get 5m in a 50/50 split.  But that 5m is probably 150k cost basis, and 4.85m "gains".  So the government would tax that gain as a taxable withdrawal.... and at 50% tax rate in California, it's probably something like 2.425m in taxes to be paid... so then the courts would likely take more of my assets to help her settle the tax bill.

 

All this despite the tax bill supposedly already having been settled at time of Roth conversion.

 

It's a double tax.

[Williams406]

One other consideration wrt roth/traditional question is that I believe Roth IRA's have no required minimum distributions at age 70.5 like traditional IRA's.

 

406

[Guest longinvestor]

One other consideration wrt roth/traditional question is that I believe Roth IRA's have no required minimum distributions at age 70.5 like traditional IRA's.

 

406

 

+1. This, in my case leaves Roth as the only real option. If I allow it to happen, MRD's will likely take financial control away from me during the out years. 

[CorpRaider]

That's all true, racemize.  I guess I have a trust issue with the government. I think the world has decided that when people are hurting, those who have saved have responsibility to bail out those who haven't.  So I can see a day when they come after these accounts.  It has already been proposed and I have heard that other governments have double dipped into people's retirement accounts (I think it was in Australia.  If anyone has stories like this I'd like to hear them).  If it was 100% certainty that the roth would not be touched it would be less complicated. 

 

Eric brings up another good point about divorce.  I honestly didn't know that they were treated differently.  I kind of figured all assets were split up 50/50 (or maybe more like 70/30 according to some I've talked to) in a divorce.

. They could raise rates, they could cap the roth exclusion, they could change rmd rules.  You can control distributions and converions from traditional, you can control if you leave california for florida for 10 years, or forever...race's analysis is accurate if you max.  You could also just take the excess cash from the tax deduction from the traditional and put it in mkl or brk till you die off and get the stepped up basis...tell me what your rates are now and what they will be in the future and i can give you the right answer.  Since thats not knowable, you could hedge the tax risk by taking the current deduction for your mediocre 401(k) investment options and put your 30% APR, brilliant personal investments in the roth.

[bargainman]

also note the income limits.  You may not be able to get deductions for the Traditional IRA above some income.  In that case you can't get a Roth directly, but you can do the ->Traditional->Roth transfer to get around it..

[Josh4580]

Eric brings up another good point about divorce.  I honestly didn't know that they were treated differently.  I kind of figured all assets were split up 50/50 (or maybe more like 70/30 according to some I've talked to) in a divorce.

 

 

So if I have a 10m Roth IRA with a cost basis of 300k, she would get 5m in a 50/50 split.  But that 5m is probably 150k cost basis, and 4.85m "gains".  So the government would tax that gain as a taxable withdrawal.... and at 50% tax rate in California, it's probably something like 2.425m in taxes to be paid... so then the courts would likely take more of my assets to help her settle the tax bill.

 

All this despite the tax bill supposedly already having been settled at time of Roth conversion.

 

It's a double tax.

 

So just wait to get married until after age 59.5.  That is my plan :)

[bookie71]

I guess I'm missing something.  Since a Roth is non taxable when withdrawn, how are you paying tax?  If done properly through a  domestic relations order ((DRO( I think it is called)) the ex-spouse would be liable for any tax, but as it is a Roth there probably wouldn't be any.

What am I missing?

[ERICOPOLY]

I guess I'm missing something.  Since a Roth is non taxable when withdrawn, how are you paying tax?  If done properly through a  domestic relations order ((DRO( I think it is called)) the ex-spouse would be liable for any tax, but as it is a Roth there probably wouldn't be any.

What am I missing?

 

It only becomes tax-free when you are 59.5.

 

Any gains withdrawn from the account before 59.5 is a taxable gain (secondary taxation).

 

Until you are 59.5, you can only withdraw tax-free the amount that you contributed or the value at time of Roth conversion.  Even if you try to withdraw that already-taxed money, they'll still hit you with an early withdrawal penalty if you attempt this within 5 years of Roth conversion or after-tax contribution (I think the penalty is 10%).

 

[ERICOPOLY]

But that's also one benefit of Roth conversion.

 

If you do want to take it out early (without paying that 10% penalty), then do a full Roth conversion and wait 5 years.  Then you can take the "day of conversion" value out of the account without penalties (leaving behind whatever gains are left since conversion).

 

You are allowed to take out the already-taxed contributions and already-taxed conversion money first.  That's sort of nice.  So you can cherry pick some of it for a completely tax-free withdrawal before 59.5 -- but as long as you've waited 5 years.

[matjone]

I found the article on the australian tax.  http://www.sovereignman.com/finance/the-next-domino-australia-doubles-tax-on-retirement-savings-11618/

 

The way things really seem to work, whatever doesn't get you voted out is fair game.  If most people have less than x in the bank, and the gov needs money, you just take some money from everyone with more than x.  There aren't that many of them, what are they going to do about it?

[OracleofCarolina]

You can always take out your Roth contributions without a tax or penalty. Contributions come out first and there is no 5 year holding period requirement.

[Gamecock-YT]

Traditional and convert to Roth, but I'm planning on early retirement.

 

 

 

http://www.madfientist.com/traditional-ira-vs-roth-ira/

[Packer16]

Interesting ideas about HSAs also on that site.

 

Packer

[ERICOPOLY]

You can always take out your Roth contributions without a tax or penalty. Contributions come out first and there is no 5 year holding period requirement.

 

You're right about that.  The 5 year waiting period is only for money that was "converted" to RothIRA.

[sswan11]

Looks like Roth IRA rules may be changing:

 

Beware Leaving a Roth for Heirs

Idea Makes Sense, but New IRA Rules Could Make the Decision Harder

 

http://online.wsj.com/articles/should-i-leave-a-roth-to-my-heirs-1410120116?mod=e2tw