Answer of Kathy Kraeblin, Virchow Krause @ Co.:
For some people, yes. Let’s consider the retirement vehicles available and narrow down your choices.
The vehicles individuals can use to invest for retirement include deductible IRAs, Roth IRAs, 401(k) plans, and nondeductible IRAs.
Here is the simple part. If you are eligible to participate in a 401(k) plan through your employer and the company matches contributions, you should make contributions to the 401(k) up to the match and then make IRA contributions if you have additional money available to invest and IRA “phase-out” rules don’t apply.
The ability to make contributions to a deductible IRA is phased out for individuals who are participants in an employer-sponsored plan, such as a 401(k). The phase-out starts at $50,000 for married persons and $30,000 for singles.
For individuals who are not participating in an employer-sponsored plan, there is no phase-out on deductible IRA contributions. For a Roth IRA the phase-out starts at $150,000 for married persons and $95,000 for singles.
If your income level is such that you cannot make a deductible IRA contribution, do a Roth. If you are above the income limits for a Roth do a non-deductible IRA and consider converting to a Roth in a later year if your income level permits. (There is a special set of rules regarding conversion of a regular IRA into a Roth.)
What if you could do either a deductible or a Roth? Is a tax deduction now worth the disadvantage of taxable income in later years? Is the advantage of tax-free distributions in the future worth missing out on a deduction currently?
The answer depends in part on the period of time before you will need to start taking distributions. With a traditional IRA, you must take minimum amounts out each year starting at age 70 , but Roth IRAs are not subject to these rules. Another factor is whether you will be in a different tax bracket when you retire.
If you will need the money within five years, use the deductible IRA. If you can leave the money in the IRA for 15 years or more, the Roth will almost certainly be the better choice. If you won’t need the money at all and intend to leave it for your heirs, definitely put it in the Roth. If you will need the money within five to 15 years, and especially if you expect your income tax bracket to be lower in retirement, the decision is not at all simple.
Answer of Michael Jungen, Jungen & Associates
A qualified “yes”. A Roth IRA is uniquely characterized by the reverse nature of the tax benefits it provides, offering no up-front tax deduction in return for withdrawals that are free from federal income taxes.
Regular IRAs may provide for a tax deduction of the contribution (depending on Modified Adjusted Gross Income – MAGI) and to the extent they do, withdrawals are taxable. Unlike regular IRAs, Roth IRAs are uncomplicated by any participation in an employer retirement plan. Money in a Roth IRA accumulates tax-deferred, so your contributions and earnings grow free of taxes while they remain in the account.
To be eligible for a full $2,000 Roth IRA contribution, MAGI cannot exceed $95,000 for individuals or $150,000 for married couples filing jointly.
All Roth IRA contributions may be withdrawn at any time without taxes or penalties. Earnings may be withdrawn from Roth IRA tax-free after five tax years in the account and attainment of age 591/2, disability, or death.
First-time homebuyers can access up to $10,000 penalty-free after five years, regardless of age. Withdrawals are considered to be taken first from contributions, and then from earnings. That means broader access to your money than with a Traditional IRA. If the five-year holding period is met, withdrawals by your beneficiaries are also tax-free.
Withdrawals of earnings under any circumstances are includible in gross income and subject to ordinary income taxes and a 10% penalty tax if taken before age 59-1/2.
Distributions from a Roth IRA don’t have to be taken until you’re ready. Since there are no distributions required, your money continues to accumulate until you need it, or you can pass it along to your heirs. Because of the tax-free treatment, this feature can provide greater opportunity for the funding of a decedent’s Credit Shelter By-Pass Trust when compared to a regular IRA.
Rollovers are allowed from Traditional IRAs to Roth IRAs only for those with MAGI under $100,000 and rollover amounts are included in taxable income. The decision of whether or not to convert is complicated and beyond the scope of this column.
Now let’s compare the two: Assume a 42-year-old is able to make deductible contributions to a regular IRA. He’ll contribute $2,000 annually to age 67 at which time he’ll make withdrawals over the next 20 years. He earns 10% the entire time. If his combined tax bracket while contributing and withdrawing is 35% and he reinvests the tax savings from the deductions from the regular IRA, his total after-tax income from the regular IRA would be $383,171 and the Roth $462,072. If we change the tax brackets to 35% and 20% respectively, the after tax payout of the regular IRA increases to $454,045. If he ends up in a higher tax bracket at retirement, say 45%, the regular IRA payout decreases to $335,487 vs. $462,072 for the Roth IRA.
June 1998 Small Business Times, Milwaukee
