November 18, 2010

Examples Questioning if the Roth IRA is the Right Choice

This week I'm going to do a series of posts looking at some example situations and deciding if a Roth IRA or a traditional IRA is the "right" choice for the individuals in question.    All of the examples are fabricated and not real people.   I'm using common surnames to differentiate the examples.   I'm trying to pick some common situations that families may find themselves in and then examine if they should go with a Roth or traditional given the situation. 

The unknown future

All my analysis in the examples is based on current tax rates.   However we can take it for granted that the tax rates will change in the future. It is the prevailing popular opinion that taxes have nowhere to go but up.  I'm not entirely convinced that is the case.   But if taxes do go up then I really don't think they will go up substantially for people in low and medium income levels.   This is just my opinion of course and I do not own a good crystal ball.   We can look back at the History of Marginal Tax rates at Median Income earners to see what the top tax rates have been over the years for people in the middle income levels.     From 1947 to 2009 the marginal tax rate at median income level ranged from 15% to 28%.   The average was 23.5% and the median 24.6%.  32 years the rate was lower than 25%, 10 years it was 25% and 20 years the rates were 26-29%.    Most of the time over the past 6 decades people making median income paid a top marginal tax rate lower than 25%.  

Whats this Mean to You?

The examples are just examples to illustrate the different situations that a Roth or a traditional IRA may be better.   I am not saying Roth IRA's are bad or that you should avoid them.   Nor am I saying that traditional IRAs are good or bad.   Sometimes Roth IRAs are better and sometimes traditional IRA's are better.   Nothing about the future is certain.  If tax system changes considerably one way or the other then todays 'right choice' may turn out to be the worse option.   I don't think taxes will change radically in future decades but thats just my opinion based on what the tax history has been.  

You should consider your own retirement savings options based on your current and expected future tax implications.

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