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Much Better Than David Lee Roth!

Rick Roeder       February 2010

When 1997 legislation created Roth IRA’s, Americans should have been “Dancing In The Street” or at least willing to “Dancing The Night Away.” Roth IRA’s flout the traditional tax planning rule of deferring taxes now, even at the cost of paying some taxes later. With Roth IRAs, you can forego the immediate $5,000 deduction ($6,000 if you are on the AARP side of age 50) associated with establishing a traditional IRA in favor of making a like contribution with after-tax dollars. However, any investment income on Roth contributions will not be taxed when withdrawn.

Roth IRAs have other advantages.

• There is greater flexibility in the manner in which monies are paid out. In a traditional IRA, there are minimum required distributions, all taxable, after attaining age 70 ½. No such requirements exist with a Roth.


• If you have not attained age 59 1/2, there is an advantage to certain Roth IRA withdrawals that do not exceed your tax basis, compared to the income and potential excise taxes associated with a withdrawal from a traditional IRA.


• The added flexibility in Roth distributions have indirect benefits. Such planning can optimize much Social Security benefits may be subject to taxation or the amount payable for Medicare Part B premiums.


• Certain income limits are higher for Roth IRA eligibility than traditional IRA eligibility.

The benefits of Roth are not restricted to contributing new money. There is a significant law change starting in 2010. The availability of converting a traditional IRA to a Roth IRA is expanded. Prior to 2010, such conversion was not available if the taxpayer’s modified adjusted gross income exceeded $100,000. However, this restriction goes away in 2010 and “Feels So Good.” For those who think tax rates are as low as they will get in the indefinite future, it may make sense to “Jump” at the opportunity to convert now before taxes go up – as seems likely when current tax rates "sunset" in 2011 – particularly if some form of health care reform passes this year.

If you ask for any hard and fast rules as to who should establish a Roth, “You Really Got Me.” However, some general guidelines are helpful:

1. The younger you are, the more attractive a Roth is.


2. The higher the immediate tax savings, the more attractive a traditional IRA. Traditional IRAs would be more attractive for “California Girls”, other factors equal, than a “Pretty Women” in Texas or “Beautiful Girls” in Florida because of the Golden State’s high marginal tax rates (in contrast to no state income taxes in 7 states, including Texas or Florida)


3. The higher your assumed future investment earnings are, the more attractive a Roth is. Low assumed future earnings favor a traditional IRA


4. Converting from a traditional IRA to a Roth is much more attractive if the monies to pay the tax on conversion are available outside the IRA.

A few examples will provide some insight.

Example #1A: Traditional IRA

No prior IRA monies
Now Age 40
Maximum future annual IRA Contributions
35% Marginal Tax Rate
Illustrative Lump Sum Withdrawal at Age 65
6.5% Assumed Investment Yield

Amount at Age 65 After Taxes

Annual IRA Contributions	$221,000
No IRA Contributions (save same amount with after-tax dollars)	$159,000
Benefit of Saving Via A Traditional IRA	$62,000

Example #1B: Comparing Roth IRA to Traditional IRA

Same as Above Example #1A Except:
Higher 45% Marginal Tax Rate Starting at age 55

Amount at Age 65 After Taxes

Annual Roth IRA Contributions	$212,000
Annual Traditional IRA Contributions	$187,000
Benefit of Saving Via A Roth IRA	$25,000

Example #1C: Benefit of Roth Conversion in Low-Tax Year

Same as Above Example #1A Except:
Unemployed for most of year at age 45; Conversion from traditional IRA to Roth IRA at age 45 during the only future year when marginal tax rate drops from 35% to 20%; traditional IRA contributions made from age 46 to age 65.

Amount at Age 65 After Taxes

Roth Conversion at age 45 with Later Traditional IRA contributions	$239,000
Annual IRA Contributions Without Age 45 Roth Conversion	$221,000
Benefit of Converting to a Roth IRA at age 45	$18,000

When it comes to savings, too many Americans take an “I'll Wait” attitude toward building a retiree nest egg. Such lack of foresight is tantamount to “Runnin' With the Devil.” This is especially dangerous for multiple income households. When a married person loses a spouse due to death or divorce, later in life, and “Ain't Got Nobody,” the importance of starting to save early is particularly critical.

Regardless as to whether a traditional IRA or a Roth is best for you, the most important element in your financial security is to plan now and be consistent. “Why Can't This Be Love” for those who see the wisdom in saving? Start now and “Finish What Ya Started.” Once-in-a-while IRA contributions are “Not Enough” for most. Disciplined planning can help your golden years feel “Just Like Paradise.” Or at least “Panama”! Rick Roeder, FSA San Diego

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