tax deferred vs tax free?

Question

I made a posting earlier on here about IRA withdrawals. So this topic relates to IRAs perfectly. There is always a question about which is better. If you are anticipating a lower tax bracket at retirement, then tax deferred(traditional IRA) might be better. If you think that you will be in a higher tax bracket at the time of retirement, then paying current income tax in the hopes of tax free(Roth IRA) withdrawals. But remember, you also pay current income tax on traditional investments also. One reason I tend to favor tax deferred more money is being put to work immediately without taxes, meaning a better return at retirement as oppose to tax free, in which contributions will be taxed annually. If investing$ 5,000 annually, that whole $5,000 goes towards the account. With a Roth, if you pay 20% income tax, that will come out of your contribution, which will leave only $4,000(5,000-20%(1,000)=$4,000). See the difference. Why not go with a traditional?

With a traditional, you withdraw money based on your current tax bracket. Why not get another job that doesn't pay much so you will end up in a lower tax bracket after retiring from your main job. Now, instead of paying 20% on withdrawals, you may be paying, say 10-15%. That may not seem like much of a difference, but it could mean thousands, especially if you are already in the 25-38% income tax bracket. Also, if you have a 401(k) plan at your current job, you could diversify retirement by contributing to a Roth. That way, you get tax free and tax deferred withdrawals while in a lower tax bracket. Make sense? First year business major. Came up with that second job concept myself, though it may not be a new one.

Another great reason for tax-deferred; with a traditional IRA, your full contributions go towards retirement. With a Roth, you pay taxes on contributions before you even make any money!

Answer 1

Go tax deferred. As an example, zero coupon tax free municipal bonds accumulate at tax free rate leaving more to accumulate and more at the end. If they are from your state, they can accumulate at state tax free as well. That saves an additional 6-10%. I like the way you think.

Answer 2

Tax Deferred Vs Tax Free

Answer 3

Your reasons are a good argument for the benefits of a traditional tax-deferred plan.

However, a young person in a low tax bracket would be much better off with a Roth IRA. Certainly a person in a zero tax bracket would be better off with a Roth IRA.

Two other advantages of a Roth IRA:

Your Roth withdrawals do not count toward the computation of tax on your Social Security benefits.

You do not have to take required minimum distributions from a Roth. You can leave it there forever and have your heirs get it if you want.

Older people, who have to take RMD anyway, can rollover some of their tax-deferred retirement money into a Roth and reduce the RMD for future years, and still have that money available if they live to be really old....and a lot of old people are living way past 85 these days.

Answer 4

The benefit to the Roth IRA is that the interest will grow tax free. So when you withdrawal the money when you retire you will not have to pay income tax on the iterest that you gained. In comparison to the Traditional IRA, in which the money is initally not taxed but when you withdrawal the money you will have to pay income tax on the pricipal as well as the interest earned. The overall benefit of the Roth is enhanced as the interest is compounded.

Answer 5

The reason why is taxes are going to increase as well as tax brackets. Many tax breaks currently given will expire in 2009. The tax code will change drastically then. If you do your research and study the tax code you will see the benefits of a Roth outweigh a traditional IRA. If things remained the same you assumption would remain true. Read JK Lassers 1001 Deductions and Tax Breaks 2007. It explains the present and future of taxation you will be shocked to find out many things are about to change.

Answer 6

It takes more than I have room to explain on here, but assuming you stay in the same tax bracket, the Roth and the Traditional will net you the same amount of money after taxes.

The reason I favor the Roth is that you can withdraw YOUR contributions (but not your earnings) at any time in the event of a financial emergency, since you've already paid the taxes on that.

Answer 7

Is 60% of 7 -- what you have after tax on the taxable investment -- more or less than 5? Do the math; it's 4th grade stuff.