Is Roth IRA best in my situation?

[Zedon]

I have read on many sites the back and forth between roth and traditional IRA. It seems most prefer the traditional but I think it depends on one's circumstances.

For me I am well into the 25% tax bracket.
I am almost 40 and have been at my job for nearly 15 years, the plan is I will be here another +20 years. There will be no breaks in my employment.
I will be getting a pension, probably 75-80% of my salary so I will still be well into the 25% bracket when I retire just from the pension. Maybe in 28% if I get another job after.

So the question is do I put money into a roth or a traditional IRA. With a likely equal or higher tax bracket and no breaks to roll it over. I currently pay about 8% into my retirement pension. Another 8% into my 457. Both the money for Pension and 457 are pre-tax money. I can invest another little bit into either a roth or traditional IRA. Amount is determined by what I have left at the end of the year.

For those educated on these matters am I wrong in thinking that a roth would be better since my tax rate will most likely be the same once I retire and I may not even need this money myself?

Thanks

[Chris Leese]

If you believe you will be in a higher tax bracket in your retirement years, than I would do a Roth IRA --- why not pay the lower taxes now on what you contribute only versus paying higher taxes later both on what you contributed and on any appreciation/growth.

I have both traditional IRAs and Roth IRAs. I now tend to favor the Roths because my goal is to be well-off in my retirement years so do not really plan to be in a lower tax bracket then. Plus, with the US debt and economic issues that prevail today, who knows where tax rates will be when I retire but my guess is that they are most likely to be higher (versus lower than currently)...

[Wino]

The Roth wins almost every time if you get a decent return on your investment. I worked out a spreadsheet. Below are the break-even years for the Roth. This assumes $5K per year into the IRA, and a 25% tax bracket both before and after retirement, with a static $100K income.

1% = IRA wins; Roth never breaks even
2% = as above
3% = as above
4% = Year 31
5% = Year 27
6% = Year 21
7% = Year 19
8% = Year 15
9% = Year 15
10% = Year 13

So, depending on the number of years until retirement, and the average return on your investment, either of the investments might come out ahead. The higher your returns and the longer you'll be invested, the better the Roth is for your retirement. By the way, the amounts by which Roth "wins" over a 40 year period can be very high. For example, at 5%, you'll have $58K more money after 40 years. At 8%, you would have $58K more after only 28 years, and $260K more after 40 years.

So, what assumptions are you making and how much longer until retirement?

[ProjectDebtRelief]

Maxing out a Roth IRA whether you have a pension or 401K as well, is almost always a good idea if you have additional money to invest.

As Wino was kind enough to break down, the writing's on the wall when it comes to how well a Roth IRA can serve you when it's done long term.

[disneysteve]

It seems most prefer the traditional

I don't know who the "most" are that you're referring to. Pretty much everything I hear or read favors the Roth if you qualify. I certainly favor it personally. I'll take the known over the unknown everytime.

I will be here another +20 years. There will be no breaks in my employment.

How do you know that in the next 20+ years, there will be no breaks in your employment? Not that it's relavant to the topic at hand but I thought it was an interesting statement to make.

[Zedon]

I don't know who the "most" are that you're referring to. Pretty much everything I hear or read favors the Roth if you qualify. I certainly favor it personally. I'll take the known over the unknown everytime.


How do you know that in the next 20+ years, there will be no breaks in your employment? Not that it's relavant to the topic at hand but I thought it was an interesting statement to make.

I have no desire to leave my job and noone ever gets fired unless they do something really wrong like a felony or stop showing up completely. In my 15 years I have not seen anyone above entry level get fired. So short of a tragic accident or a mental break by me I will have this job as long as I want. It is a union job so there are a lot of protections and even if there was massive lay offs due to budget shortfalls it goes by seniority and I already have 15 years in so not likely they would reach me. So unless an amazing deal comes from another employer I will be sticking where I am.

So, what assumptions are you making and how much longer until retirement?

Well I hope this IRA is the last thing I touch. So if I have to start taking money out it would be between 70 and 75 or never. So I have at least 30-35 years to grow it.

[Wino]

I have at least 30-35 years to grow it.

Then you would almost assuredly benefit most from the Roth. I also second DSteve's comment that I almost always hear folks favoring the Roth over the traditional. If future taxes go up, the Roth wins by even more. Considering the current inability of Washington to say, "No" to anything, I think higher taxes are more likely than static or lower taxes.

[disneysteve]

Well I hope this IRA is the last thing I touch. So if I have to start taking money out it would be between 70 and 75 or never. So I have at least 30-35 years to grow it.

You definitely want a Roth since it has no minimum withdrawal requirements (among other reasons). You don't have to touch it unless you want to. If you never need it, it can continue to grow tax free until your death and then pass to your heirs.

[MakeAStash]

It's all about the taxes. If the tax rate upon withdrawal is the same as you pay now, tIRA and Roth end up being equal in after-tax value. If you expect your tax rate to be higher during withdrawal time, choose Roth now, otherwise choose tIRA.

[Petunia 100]

I think having both is the best approach. You already have a pension and some tax-deferred going. Keep that up, and contribute to a Roth too.

[Wino]

It's all about the taxes. If the tax rate upon withdrawal is the same as you pay now, tIRA and Roth end up being equal in after-tax value. If you expect your tax rate to be higher during withdrawal time, choose Roth now, otherwise choose tIRA.

This is not correct. If I invest $10K tax free, it grows to $160K over 30 years at 10% per year (ballpark), and I then pay taxes on that amount, not on the $10K That's a much greater tax hit. I used those figures to show the point where the tax benefit equation switches up above. Your actual tax rate has less to do with it than the amount you earn. The higher your rate of returns, the more likely the Roth is to be the best vehicle, tax wise. Of course, no one knows what the rate of return will be, but indexers often use 8 to 12% as their expected returns, and are not often disappointed for more than a couple of years out of a decade.

[Wino]

I think having both is the best approach. You already have a pension and some tax-deferred going. Keep that up, and contribute to a Roth too.

Unless you live overseas and get a $96K per year tax deduction.

[Petunia 100]

This is not correct. If I invest $10K tax free, it grows to $160K over 30 years at 10% per year (ballpark), and I then pay taxes on that amount, not on the $10K That's a much greater tax hit. I used those figures to show the point where the tax benefit equation switches up above. Your actual tax rate has less to do with it than the amount you earn. The higher your rate of returns, the more likely the Roth is to be the best vehicle, tax wise. Of course, no one knows what the rate of return will be, but indexers often use 8 to 12% as their expected returns, and are not often disappointed for more than a couple of years out of a decade.

It is correct, though. It's called the commutative property of multiplication and it is always true.

I think where you are making your computational error is you are ignoring the fact that 10k into tax-deferred only costs 7.5k (assuming 25% tax bracket).

If 10k goes into tax-deferred and compunds for 30 years at 10%, it will grow to $174,494.02. If it is taxed at 25% as it comes out, then $130,870.52 will be the net.

If 7.5k goes into tax-free and compounds for 30 years at 10%, it will grow to $130,870.52.

All figures calculated using the future value function in Excel.

[Zedon]

It is correct, though. It's called the commutative property of multiplication and it is always true.

I think where you are making your computational error is you are ignoring the fact that 10k into tax-deferred only costs 7.5k (assuming 25% tax bracket).

If 10k goes into tax-deferred and compunds for 30 years at 10%, it will grow to $174,494.02. If it is taxed at 25% as it comes out, then $130,870.52 will be the net.

If 7.5k goes into tax-free and compounds for 30 years at 10%, it will grow to $130,870.52.

All figures calculated using the future value function in Excel.

So from this the key factor seems to be whether you have the money to fully invest in either mode since in the end the roth will give you more for the same amount of money initial invested in the ira. If you are only going to partially fund, a non roth may be better depending on retirement tax rate which is a bit unknown for the vast majority, but some have a fair idea.

The other factor for me is I live in CA which put me in the 9.3 tax bracket currently, If I do non roth I would be saving that much more only if I live somewhere when I retire that has no or low state tax rate.

Am I correct that state taxes are also deferred for traditional IRAs?

[Petunia 100]

So from this the key factor seems to be whether you have the money to fully invest in either mode since in the end the roth will give you more for the same amount of money initial invested in the ira. If you are only going to partially fund, a non roth may be better depending on retirement tax rate which is a bit unknown for the vast majority, but some have a fair idea.

The other factor for me is I live in CA which put me in the 9.3 tax bracket currently, If I do non roth I would be saving that much more only if I live somewhere when I retire that has no or low state tax rate.

Am I correct that state taxes are also deferred for traditional IRAs?

I think you have to look at your whole situation. For you, since you have a pension, you are going to have 3 sources of taxable income already. A Roth would give you access to funds tax-free. This could come in quite handy. You could access the funds as desired without triggering additional tax.

States make their own income tax laws. California does conform in this area; if you are able to deduct on your federal return, you may take the same deduction on your state return. I don't know if other states do or not (I am also in California).

Since you do participate in an employer's plan, you may or may not be able to deduct traditional IRA contributions. Please see the link following. However, you do have the option to max your 457.

http://www.irs.gov/Retirement-Plans/2013-IRA-Deduction-Limits-Effect-of-Modified-AGI-on-Deduction-if-You-Are-Covered-by-a-Retirement-Plan-at-Work