why do people love roth IRAs?

[deca]

I always see people talking about Roth IRAs versus traditional. Can you do max out on both in one year? In "Start Late, Finish Rich," the author really favors traditional IRAs because the contributions are pre-tax now. He says that lets you afford more dollars to contribute today. When the withdrawals are taxed at a later date, they will presumably be at a lower rate. I'm just wondering what the counter-argument is since so many people seem to go for the Roth instead.

[disneysteve]

When the withdrawals are taxed at a later date, they will presumably be at a lower rate.

Here is his flaw. We are currently enjoying historically low tax rates. Most any expert/economist you can find will tell you that rates are likely to rise in the future. So chances are good that my tax rate in retirement will be the same or higher than what I'm currently paying. I'd rather lock in the taxes at today's rate and get tax-free income at future rates.

[deca]

Okay, that helps...I actually think our tax rate is fairly low now, between the home mortgage interest deduction, child care expenses, student loan interest, deducting health care premiums pre-tax, etc...we have had very little tax liability in recent years.

So our contributions now are practically pre-tax, and the withdrawals later will be tax-free, is that right?

[ktmarvels]

No, contributions to a Roth are post-taxes.
At some point in time the government will tax the money. With Roths you pay the taxes now (and don't have to pay taxes on the withdrawls). With traditional IRAs you only pay taxes on the withdrawls. As mentioned before, we know the tax rate now, but not in the future so thats why Roths a good option.

[kv968]

So our contributions now are practically pre-tax, and the withdrawals later will be tax-free, is that right?

Contributions to a Roth are post-tax and are tax-free when you withdrawl them. Traditional contributions are tax-deductable now but you will pay taxes on the contributions AND earnings when you withdrawl them.

And to answer your other question, no you can't max out both in one year. For instance, the maximum contributions allowed this year for most people is $4000. You can split that up between a traditional and a Roth but the overall total can't exceed $4000.

[deca]

Contributions to a Roth are post-tax and are tax-free when you withdrawl them. Traditional contributions are tax-deductable now but you will pay taxes on the contributions AND earnings when you withdrawl them.

Not sure if I was clear in what I was trying to say, that you responded to -- but since our current tax liability is very low anyway, the "pre-tax" advantage of contributions to a traditional IRA is almost a moot point. We might as well contribute to a Roth instead and have the advantage of tax-free withdrawals later. Is my logic right on that?

[Ima saver]

Well, I prefer the roth, but I have both. So, I will have to pay tax on my IRA when I start taking the money out.

[Fizgig]

Something else that I like about a Roth is that you can withdraw your contributions (not earnings) at any time, without a penalty or taxes due. That makes it kind of a "Holy Crap!" fund, above and beyond a traditional emergency fund.

I wouldn't want to withdraw money from a Roth pre-retirement, but sometimes life throws a curve ball and it's nice to have options.

[CoryWM]

How goes the return on the money get taxed on each? Or is it the same?

Say:
$1000 in a Roth IRA
$1000 in a Traditional IRA

Lets say you get a 10% return. Before you retire. And only only opened the account 1 year before you retired, for the purpose of making this easy.

You'd have $1100.
Roth IRA- Pay tax on the 100? or would it be free of tax also?

Traditional Pay tax on the whole 1100 I assume?

[Fizgig]

Cory - With a Roth, earnings are not taxed at all if you withdraw after the age of 59.5. You contribute with post-tax dollars, and are then never taxed again as long as you're old enough when you withdraw.

Of course, that's how it is right now. Congress could change the rules over the next 30 years and decide to tax withdrawals, which would suck big time.

Edit - With a Traditional IRA contributions are tax deductible, and total distributions (contributions + earnings) after age 59.5 have income tax due.

Another edit - sheesh! One peculiarity with Roth IRAs is that tax-free distributions are possible only if the money has been in the account for more than five years. So, if you retired one year after depositing that money, you'd have to wait five years or pay a penalty. I don't know if that applies to early withdrawals of contributions, though - anyone know?

[kv968]

Not sure if I was clear in what I was trying to say, that you responded to -- but since our current tax liability is very low anyway, the "pre-tax" advantage of contributions to a traditional IRA is almost a moot point. We might as well contribute to a Roth instead and have the advantage of tax-free withdrawals later. Is my logic right on that?

Yes your logic is right on that.

[kv968]

One peculiarity with Roth IRAs is that tax-free distributions are possible only if the money has been in the account for more than five years. So, if you retired one year after depositing that money, you'd have to wait five years or pay a penalty. I don't know if that applies to early withdrawals of contributions, though - anyone know?

Your contributions can be taken out at any time without a penalty.

[LivingAlmostLarge]

Roths are great if you qualify for them. That's the other catch, you have to make less than X amount of dollars. Although if you don't qualify it may not be the best choice.

[pearlieq]

Another argument for a Roth IRA instead of a Traditional is that the income limit for deducting your contribution to a Traditional is fairly low and depends on whether you have a retirement plan at work.

DH and I aren't eligible to deduct a Traditional IRA contribution, but can still benefit from a Roth.

Plus, if things turn out like I plan, I have no intention of being in a lower tax bracket when I retire!!!

[lgslgs]

Your contributions can be taken out at any time without a penalty.

This is really useful if you retire early (before 59.5).

Lynda