MIAMI (TheStreet) -- If you are qualified for either a Roth or Regular IRA, or your 401(k) plan offers a Roth and a regular, which should you choose? Unfortunately, no one can give you an absolute answer, but here are some of the considerations:
First, always remember that our government could change the tax laws at any time. Changing to a flat tax, for instance, would probably be a disaster for Roth economics. What Uncle gives, he can take at any time. But, still, it's highly unlikely the government would change Roth tax-free distributions for existing plans.
No one can give you an absolute answer which is better, but there are some IRA details to consider.
Having said that, if tax advantage is a driving factor for you, here are some tax guidelines:
- If you expect to be in a lower bracket after you retire than when you make the contribution, go for a regular IRA or 401(k).
- If your tax bracket will be higher during withdrawal, a Roth will end up with a higher value for you.
- If your tax bracket will be the same, there won't be a penny's worth of difference to you.
So as your income changes you may make different choices.
If you are in a very low tax bracket, the value of a "lost" or "wasted" deduction is small, so a Roth is a no-brainer.
In most cases, Roth IRAs and 401(k)s offer more flexibility than a regular IRA:
- There are no forced distributions at age 70.5. The lack of forced distributions should be helpful to anyone fearing their retirement accounts might be substantially depleted as they age.
- You can continue to make contributions after age 70.5.
- Roth is a possible source for education or other large future expenses because you can always withdraw contributions without penalty or tax. For instance, if you were to make just a $2,000 deposit each year after your child was born, you could withdraw $36,000 (or $72,000 for a couple depositing $4,000 a year) without penalty or tax when the child reached 18. The remaining accumulation can continue to grow until you retire after age 59.5. So your funds are not tied up as they would be in a regular IRA.
- Roth really shines as an estate planning tool. Especially if you think you may not need to spend the money during your lifetime, the ability to prepay income taxes for your next generation makes it worth far more than a traditional IRA or 401(k). Unlike the traditional, the Roth can be conveniently used to satisfy the Uniform Credit amount. There is no wasted credit amount due to income tax.
You will notice I haven't mentioned nondeductible IRAs. That's because I don't think they are such a great idea. The Roth is a far better choice. Here's why:
- There is no current tax deduction.
- Investments inside the nondeductible IRA will get ordinary income tax upon distribution. So you are giving up the opportunity to pay capital gains rates on your accumulations.
- If you really need your money before age 59.5, you may be subject to the 10% early withdrawal penalty.
- You will be forced to make distributions at age 70.5.
- Gains will be subject to income tax in your estate.
- Accounting for basis on withdrawal is an aggravating tax problem because all withdrawals must be apportioned between deductible and nondeductible accounts. Not fun.
The only reason to make a nondeductible IRA contribution is if your income exceeds
. In that case you can make a nondeductible contribution and immediately convert it to a Roth. It's a strange way to work around the contribution limit, but it works.
The 2012 IRA contribution/deduction limits are $5,000 if you are under age 50 and $6,000 if you're 50 or older -- and don't forget a spousal IRA will double those amounts.
If you are qualified for either a Roth or regular IRA or 401(k), by all means take advantage of it. Remember, a tax advantage is a terrible thing to waste!
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Frank Armstrong III is the founder and principal of
, a Miami-based NAPFA fee-only registered investment adviser with more than $500 million of assets under management. He holds a B.A. in economics from the University of Virginia, has more than 38 years' experience in the securities and financial services industry and has published four books and hundreds of articles on investments and retirement planning. Contact him at