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Author: WildcatFool One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121572  
Subject: Yet Another Roth IRA Question Date: 5/8/1998 5:04 PM
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Okay, I've been wondering about this, and I think I'm right, but I'd like some confirmation (or correction, as the case may be).

Let's say I have a 401k at work, and my AGI is in the 60k-100k range. My current tax bracket is X%, and my retirement tax bracket is Y%.

My current income puts me above the limit for deductible contributions to a Traditional IRA. Any money I contribute to a Trad IRA will be taxed at X% now (as I earn it), and taxed again at Y% later (when I withdraw it). Correct?

For a Roth, I am still taxed at X% on my contributions now.
Case A: Roth withdrawls are still tax free when I retire. Then I am choosing now between the Trad (Tax now at X% + later at Y%) and the Roth (tax now at X% and later at 0%). No brainer.

Case B: Roth withdrawls are taxed as income (worst case, ordinary, at Y%). Then the two options are a wash. Tax now at X%, later at Y%. Roth is at least no worse than Trad

Case C: National sales tax, at Z% of consumption. Both IRA's are now Tax now X%, later 0%, and my consumption (presumably the same regardless of IRA choice) is taxed at Z%.

In either case, unless Congress levies a "penalty" tax on Roths (Roth income taxed higher than other income), why would someone in this income group choose a Trad IRA over a Roth???

If there is a flaw in my logic, PLEASE point it out before I complete my 401(k) rollover from my former employer! :-)

OTOH, I can see that the situation would be much different were my AGI below the Trad deductible limit or the Roth income limit.

BTW, when (hopefully) our income breaks the Roth limit, what's stopping me from leaving the Roth alone, opening a second, Trad IRA, and contributing to it?

Thanks,

WildcatFool
:-)
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Author: tc001 Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3828 of 121572
Subject: Re: Yet Another Roth IRA Question Date: 5/8/1998 10:14 PM
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All of your assumptions and both conclusions are correct. In your current situation the Roth is the way to go. When your income exceeds Roth eligibility, switch to a traditional IRA.

That was also some nice analysis. It's good to see someone take the time to inform themselves and think the issues through as well as you did.

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Author: Kno1ok Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3831 of 121572
Subject: Re: Yet Another Roth IRA Question Date: 5/8/1998 11:02 PM
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My current income puts me above the limit for deductible contributions to a Traditional IRA. Any
money I contribute to a Trad IRA will be taxed at X% now (as I earn it), and taxed again at Y%
later (when I withdraw it). Correct?

There is a small flaw in this statement. The money you contributed that was nondeductible will not be taxed again when you withdraw it(under current laws, anyway). Only the appreciation will be taxed on withdrawal. I don't believe this changes the validity of your conclusions, however.

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Author: LasVegasFool One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3836 of 121572
Subject: Re: Yet Another Roth IRA Question Date: 5/9/1998 1:33 PM
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>My current income puts me above the limit for >deductible contributions to a Traditional IRA. Any
> money I contribute to a Trad IRA will be taxed at X% >now (as I earn it), and taxed again at Y%
> later (when I withdraw it). Correct?

Nope. The money is only taxed once. Nondeductible IRA contributions come out tax free. You only pay taxes on the earnings from the contributions.

>If there is a flaw in my logic, PLEASE point it out >before I complete my 401(k) rollover from my
> former employer! :-)

Flaw: Your logic only applies to contributions, not rollovers. When rolling over, you have a large sum of pre-tax money that you are paying taxes on and converting to post-tax money. If Roth monies are taxed at the same rate as income, you have lost by paying the taxes now.

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Author: tc001 Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3837 of 121572
Subject: Re: Yet Another Roth IRA Question Date: 5/9/1998 5:51 PM
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Original question:
<<Any money I contribute to a Trad IRA will be taxed at X% now (as I earn it), and taxed again at Y% later (when I withdraw it). Correct?>>

Reply:
<<Nope. The money is only taxed once. Nondeductible IRA contributions come out tax free. You only pay taxes on the earnings from the contributions.>>

Absolutley correct, but still only a minor consideration. To quibble here would also require going back to Case B (tax on Roth) which is described as a wash and pointing out that if the tax rate (Y%) increase, the traditional IRA would win since the contributions were already taxed at a lower rate (X%) and then withdrawn tax-free.

Sorry for my less than complete answer in my first post. However, your conclusions should hardly be affected by the distinction.

Original question:
<<If there is a flaw in my logic, PLEASE point it out before I complete my 401(k) rollover from my former employer! :-)>>

Reply:
<<Flaw: Your logic only applies to contributions, not rollovers. When rolling over, you have a large sum of pre-tax money that you are paying taxes on and converting to post-tax money. If Roth monies are taxed at the same rate as income, you have lost by paying the taxes now.>>

Again, correct. To quibble again, however, the money cannot be rolled from a 401k to a Roth. It can only be rolled into a traditional IRA (and from there, converted to a Roth). There was no flaw in the logic that would prevent the primary rollover. In fact, I think it is reasonable to always roll a 401k into an IRA just for the added control you get over your investments.

As far as the secondary rollover (from traditional to Roth), the last sentence of the reply lost me. One consideration for conversion is whether or not you think your tax rate will decrease during retirement. If the decrease is significant, the conversion could be a mistake. I think this is the point implied in that sentence, but I may be missing something of more importance.

In any case, you can certainly complete the 401k rollover from your former employer. The decision to make another rollover into a Roth can be delayed until you get additional information if you feel it is necessary.

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Author: LasVegasFool One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3875 of 121572
Subject: Re: Yet Another Roth IRA Question Date: 5/11/1998 9:47 PM
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>As far as the secondary rollover (from traditional to >Roth), the last sentence of the reply lost me.
> One consideration for conversion is whether or not >you think your tax rate will decrease during
> retirement. If the decrease is significant, the >conversion could be a mistake. I think this is the >point
> implied in that sentence, but I may be missing >something of more importance.

You are: He was specifically considering what Congress might do to the tax laws in the future that could hurt Roth.

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