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Financial Planning / Foolish 401(k)s


Subject:  Re: Post-tax vs Pre-tax Date:  6/20/2002  7:04 PM
Author:  Mark0Young Number:  15134 of 26268

I believe most of the thinking on the advantages of the ROTH is anticipating a lower tax rate when you are retired and not drawing an income.

Actually, no.

If one anticipates having a higher tax rate in retirement, the Roth IRA would be advantageous: pay the taxes when one's tax rate is lower so one can then access the Roth IRA money in retirement without paying any more taxes. (This is also true if one anticipates making a substantial one-time withdrawal for a major purchase: a Roth IRA withdrawal wouldn't kick you into a higher marginal tax rate, unlike withdrawals from pre-tax plans.)

If one anticipates having a lower tax rate in retirement, a pre-tax 401(k), 403(b) or similar, and deductible contributions to a Traditional IRA would be better--delay taxes until one would be paying at a lower rate.

If one anticipates having substantially the same tax rate in retirement as one currently has, then it doesn't matter so much if one is going to go pre-tax/taxable-at-withdrawal (401(k), 403(b), Traditional IRA preferably made with deductible contributions, etc.), or after-tax/tax-free-at-withdrawal (Roth IRA, and the anticipated Roth 401(k) and Roth 403(b)); either way will work, and either way would most likely be preferable to after-tax contributions to an account that would then have its gains taxed at ordinary income tax rates. If one is contributing one's maximum legally allowed amount, the Roth IRA has some advantage over deductible contributions to a Traditional IRA in that $3,000 contributed to a Roth IRA would be more valuable than $3,000 as a deductible contribution to a traditional IRA because of all money coming out of a Traditional IRA funded with deductible contributions would be taxed as ordinary income whereas if one follows the rules for removing money for a Roth IRA one can have all the money coming out of the Roth IRA tax free, the tradeoff is having had to pay taxes for money before it was available to go into the Roth IRA.

There may be other issues that might come up (qualifications for contributing to the various accounts, estate planning, protection from creditors, ability to automate contributions to such accounts, investment options and investment expenses, etc.), so one's current tax rate vs. retirement tax rate aren't the only factors one might consider.

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