IRAs v. Roths? Choose the “Absolute Benefit”

No one knows their financial future with certainty, but when given the choice, I almost always suggest taking a sure thing now (an “Absolute Benefit”) over risking an uncertain future (an “Uncertain Benefit”). In this regard, I tell all of my clients to take a tax deduction now and invest in a tax deductible IRA or 401(k) instead of contributing to a Roth IRA or Roth 401(k) plan, in order to optimize the certainty of income tax savings.


Remember that you take an immediate income tax deduction on a 401(k) or most traditional IRA contributions; you only pay taxes when you withdraw funds (usually after you are retired, and your tax bracket is lower). In contrast, Roth accounts require you to pay income taxes on the funds prior to the contribution, but, as a result, you do not have to pay taxes on the gains or withdrawals from the account. In addition, Roth accounts do not require you to take  any distributions as long as the accounts are in your name.


In the late 1990s, during my past career acting as a Certified Financial Planner ™ I had access to software that allowed me to run many types of financial calculations. At that time one common hypothetical question we illustrated for younger and less-wealthy individuals was whether it made more sense to contribute money to a tax-deductible IRA or a Roth IRA. The idea was that a person early in his career would have low income now and larger income in the future; as a result,  an income tax deduction from funding an IRA looked less attractive than paying taxes now and investing in a Roth instead.


Because the sole determining factor in this equation was when and how much money we were saving on income taxes, this calculation only made sense in a world where the laws of taxation remain static for the rest of your life.


Clearly, we do not live in a world where the laws of taxation remain the same.


In the past 20 years, since the introduction of Roth IRAs, we have seen new and differing upper and lower tax rates, differing tax brackets, permissible deductions, increased levels of permissible maximum retirement plan contributions, changes in the limits on adjusted gross income permitting certain retirement plan contributions, a lifting on income caps on Roth IRA conversions, and many other changes to income tax deductions. Also, Medicaid in New York ignores IRAs from “means testing” for asset purposes, meaning you can have substantial IRA assets and still qualify for Medicaid in New York, but this is not the case with your Roth, meaning your Roth, which you already paid income taxes upon creation and thought would never have to take a distribution, now invalidates you getting on Medicaid until you nearly fully deplete it. This is a complete and unmitigated disaster twice: You paid taxes in the past and lost the benefit in the future anyway.


And while we are on the subject of not requiring future distributions, the Obama Administration proposed mandating required minimum distributions from Roth IRAs which, while not taxable, would have essentially forced money to be withdrawn from Roths and then reinvested in investments that would then be eligible for income taxes on any gains and distributions made from them. To be clear, this legislation did not pass, and I am not berating any Administration or calling out any specific political party: I tend not to trust anyone in charge of proposing tax policy during an age of unsustainable government spending.


My point is that the answer to the “IRA or Roth” question is, was and will continue to be very simple: In a world where the rules are always changing, take the Absolute Benefit (a certain, defined, current tax deduction from contributing to a traditional IRA) even if it only saves you 10% – 20% on income taxes, over the Uncertain Benefit (who knows what the future holds for tax policy and Roth IRAs). In a world where the future is uncertain and any forthcoming benefit has no measurable risk-to-reward ratio, take a tax deduction now by investing in your 401(k) and IRA instead of investing in a Roth.

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