Roths Worth Another Look

We've all been taught the importance of pretax savings growing tax-deferred in a traditional IRA or 401(k) plan. The idea is to pay the taxes after retirement, when you'll surely be in a lower tax bracket.

But maybe it's time to rethink that advice, especially if you're just beginning your retirement savings.

A Roth IRA after-tax contribution is starting to look more and more attractive, especially if you're in your 20s and have plenty of time to grow your money tax-free. And now that the newly passed Pension Protection Act has encouraged companies to offer an after-tax Roth 401(k) option, it's more likely that you'll be faced with the pretax or after-tax decision.

It sounds like heresy, but many people -- lower-income as well as higher-income workers -- might be far better off paying taxes right now and making an after-tax contribution to this new type of Roth 401(k) plan. Companies aren't required to offer the Roth 401(k) alternative, but they may feel a lot of pressure to include the option when they realize how attractive it is to lower-paid and younger workers.

Getting Tax Perspective

The current income tax brackets are relatively low. If you're single and have income under roughly $31,000, you're paying only 15% on your last dollar earned. Historically speaking, that's a bargain compared to 1963, when the top personal tax rate was over 91% and the lowest rate was 20%!

Policymakers have ample historical evidence that lower tax rates produce more revenue -- but given the current budget deficits, it will be hard to avoid raising income-tax rates in the future.

Economist Lawrence Kotlikoff, writing in the latest bulletin of the Federal Reserve Bank of St. Louis, demonstrates the likelihood for higher taxes in the future in a study titled "Is the United States Bankrupt?" He calculates that the U.S. has an unfunded debt liability that already exceeds $65 trillion. Among the conclusions: 18-year-old workers today could face marginal net tax rates as high as 80%, when you consider all taxes!

"The fiscal irresponsibility of both political parties has ominous implications for our children and grandchildren. Leaving our $65.9 trillion bill for today's and tomorrow's children to pay will roughly double their average lifetime net tax rates," Kotlikoff concludes in this report.

2006 Tax Rates for Single Filers

10% on income between $0 and $7,550

15% on the income between $7,550 and $30,650; plus $755.00

25% on the income between $30,650 and $74,200; plus $4,220.00

28% on the income between $74,200 and $154,800; plus $15,107.50

33% on the income between $154,800 and $336,550; plus $37,675.50

35% on the income over $336,550; plus $97,653.00

Source: Internal Revenue Service

Given the likelihood of future tax-rate increases, plus the hope that you'll be earning more as your career expands, you should consider putting at least a significant portion of your money in an after-tax retirement plan to get the promised tax-free gains down the road.