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MONEY matters

Mark Zaifman's thoughts on money, global economic trends and politics

Be Tax Savvy When Deciding on a Roth or Traditional IRA Contribution

Mark Zaifman   |    Thu, Dec 23, 2010 @ 10:12 AM

choosing-the-right-IRA

Should you choose a ROTH IRA or a Traditional IRA? That’s a tax planning question that deserves much scrutiny. First thing you need to do is find out if you’re eligible to contribute to a Roth IRA. Here’s a link that can help determine the answer: Roth IRA Income Eligibility

Let’s say for argument sake you’re eligible to contribute to either a Roth or a Traditional IRA. If you take the Traditional IRA route, you’ll deduct the IRA contribution from your reported income which will have the effect of lowering your income tax bill.

If on the other hand, you go the Roth IRA route, you will not deduct the contribution from your reported income BUT when you start to make withdrawals from your Roth when retired, the good news is the withdrawals will be tax free. Here’s another good link that can help you understand how these Roth distributions work: Roth IRA Distributions

It’s mighty important to keep one major concept in mind and this is usually what blows most of my clients away. And it’s not that they didn’t know this, it’s just looking at a situation in a different way.  As Wayne Dyer likes to say; Change the way you look at things and the things you look at will change.

Consider this: Say you have $500,000 in your 401k, 403b or Traditional IRA account by the time you’re ready to retire. Next, consider that a minority owner in this account is the IRS. Remember, this money has all been tax deferred but as soon as you begin withdrawing from your account, taxes are due.

It’s reasonable to assume that you’ll most likely be in the 28% tax bracket when retired and if you live in an expensive part of the country, probably the 30% tax bracket. So $150,000 of that $500,000 is owned by the IRS ($500k x 30%=$150k). YIKES! -I didn’t consider that is how most people react to that sobering news.

Be Tax Savvy

So as you contemplate a Roth or Traditional IRA contribution, put your tax planning hat on and become tax savvy by thinking down the road how this decision will affect you in retirement.  It’s always tempting to lower your tax bill now by going the Traditional IRA route. And if cash flow is an issue, that may be the way to go.

But if you have the option and cash flow is not an issue, seriously consider the long term benefits of a Roth IRA. I believe we’ll be looking at higher and higher income tax rates in the future. Our national debt is astronomical and something has to give. In my opinion, it will be taxes, meaning higher taxes down the road.

Finally, consider the benefits of converting a portion or all of your Traditional IRA’s to Roth IRA’s while you still can. If you’re not sure how this works, what the cost/benefit analysis looks like, please contact me for a consultation to discuss whether or not this makes sense for your individual situation.