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Financial Planning / Tax Strategies
|Subject: Re: Roth versus Traditional IRA||Date: 1/31/1998 6:10 PM|
|Author: KATinChicagoland||Number: 1646 of 121563|
Lemuel presents an interesting analysis. FWIW, here are my comments.
The principal benefit of the Roth IRA is the ability to have a greater number of dollars compounding tax-free for your benefit. If you assume the tax rate at the back end will be 15%, then 15% of the dollars in a traditional IRA are compounding for the benefit of the government. In a Roth, *all* of the tax-free compounding is for the benefit of the owner.
Some taxpayers can attain this benefit at little or no cost; for them the Roth is clearly superior to the traditional IRA. For some, there is a significant cost. That is the case in Lemuel's example: to get the advantage of using the Roth IRA, the taxpayer has to give up the benefit of claiming deductions at 28% when the corresponding income will later be taxed at 15%.
The Roth wins out, even in this situation, if the money is left in the Roth long enough. How long is long enough depends on the assumptions you make. In the assumptions made here, I believe the time period is around 20 years but I haven't taken the time to model this so this is an approximation. In that case, the best strategy for Sarah is to contribute to Roth for 10 years or so, then switch to a traditional IRA. (In other words, leave the Roth intact but don't make further contributions to it.) This will produce a better result than using either type over the entire period.
Stepping back from the math, my feeling is that in any long-term situation Roth is likely to win out over a traditional IRA because of its greater flexibility and the possibility that back-end payments from a traditional IRA may end up being taxed at a higher rate than anticipated. This is based on gazing into a very cloudy crystal ball, of course. And the issue is very different when analyzing shorter term situations. In these cases, it may well be possible to predict with reasonable certainty that the traditional IRA is the better choice.
KAT in Chicagoland
Tax Guide for Investors
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