Discussion continues as to the better retirement vehicle: a traditional IRA or a Roth IRA.  Much of the disagreement centers around future tax rates; will they go up, or will they go down?  And, how will changes in the tax code affect IRA’s of either type?  Economists can’t seem to agree.  The following axiom regarding economists holds true in this situation:    

• For every economist’s opinion, there exists an equal and opposite economist’s opinion.

Two Schools of Thought

The adversaries in this discussion fall into two camps: those who believe that you should invest in a Roth IRA because taxes will certainly go up, and those who believe that the future is uncertain, so take what you can get now.  Let’s have a look at their arguments.

Taxes Will Go Up, So Invest in a Roth

Proponents of the “taxes will go up” position state that in the future, tax rates will almost certainly go up.  Currently, they say, there are multiple financial crises to be concerned with: health care, increased unemployment benefits, hard-hit pension funds, under-funded social security, and an expensive war.  Somehow, all of this must be paid for, so it is inevitable that taxes will go up.

If tax rates go up, investors who have contributed funds to a traditional IRA with the hope that their tax rate will be lower when they retire are in for a big disappointment.  They may, in fact, be paying more tax on their future withdrawals instead of less tax.

The solution, according to this camp, is to pay the tax on your contributions now while rates are low.  Then, when the money is withdrawn, there will then be no tax due at all on the withdrawals.   Having a Roth, they say, removes any uncertainly about what future tax rates will be, because there will be no tax on withdrawals at all.  With a traditional IRA, you have no choice but to start making withdrawals at age 70 ½ and pay whatever the prevailing tax rate is.      

The Future is Uncertain, So Take What You Can Get Today

The proponents of the “uncertain future” position say that knows one knows what the future will bring, so take what you can get today, i.e., an income deduction for your contributions to a regular IRA.  The thinking here is similar to the “eat, drink, and be merry, for tomorrow we die” philosophy in its fatalism: the only thing we can be certain about is today.

Income taxes could increase, or not.  Capital gains tax could increase, or not.  The US could institute a national sales tax, of a VAT tax, or a flat-rate tax.  Or not.  Who knows?  Everyone’s crystal ball seems to be broken.  

It’s the uncertainty of future tax policy that prompts this camp to preach in favor of the traditional IRA.  Take the tax deduction today.  Let tomorrow take care of itself. 

The Middle Ground

The truth is that future changes in the tax code could increase or decrease the value of either type of account, say those who assume the middle ground.  Middle-of-the-roaders recommend investing in several different retirement vehicles, according to one’s personal circumstances and attitude toward risk. 

Who knows what the future will hold?  No one, but everyone has an opinion.  Just ask any economist.

Anyone wanting to get a good understanding of retirement plans should have lots of time on their hands, some good reading glasses, and some aspirin.  The number of retirement plans available is overwhelming; there are individual retirement plans (IRA’s), and employer-sponsored retirement plans (Defined Benefit, Defined Contribution, 401K’s, Profit-Sharing plans, ESOP plans, Simple plans, Money-Purchase pension plans, and SEPs.)

Let’s take a look at the two Individual Retirement Plans (IRA’s), and see how they compare.

Traditional Individual Retirement Plan (IRA)

Regular IRA’s were created in 1975, and are no longer offered. Traditional IRA’s have been around since 1986.  They have always been a popular investment product, because the contributions made (up to $5,000 in 2010; $6,000 if you are over 50) are deductible from your income for tax purposes.  If you earn $85,000 in 2010 and contribute $5,000 to your IRA, your taxable income drops to $80,000.  The $5,000 drop saves you not only the tax on the $5,000 ($1,400 @ 28%), it drops you to a 25% marginal rate which can save you up to $14,000 in taxes, depending on your filing status and other factors.

Traditional IRA’s are a good tactical maneuver if you want to drop into a lower tax bracket.  Since no taxes have been paid on the deposit, you will have to pay taxes when the money is withdrawn.   Withdrawals must be made starting at age 70 ½.  When withdrawn, the money is taxed as if it was ordinary income.  Most retirees are in a lower tax bracket at retirement age, so the theory is that the withdrawal will be taxed at a lower rate than if taxes were paid prior to deposit.  

Roth IRA

Roth IRA’s were established in 1997.  The tax structure of a Roth is substantially different from that of the Traditional IRA.  Taxes on contributions made to a Roth are paid prior to depositing the money.  Consequently, the account owner has better access to his account funds, and the investment of funds can be done either by an account custodian or the account owner (self-directed).  Further advantages of a Roth IRA over a Traditional IRA are:

• Direct contributions can be withdrawn tax-free at any time
• Up to $10,000 in earnings can be withdrawn for the purchase of the account owner’s first home
• Assets can be passed on to heirs
• There are no age-based distribution rules.  Funds can be withdrawn once the account is five years old.

Growth is Not Guaranteed

Both the Traditional IRA and the Roth IRA are investment-based retirement accounts.  The key word here is “investment”.  Investment’s don’t always earn money, even when they are invested in blue-chip, stable companies.  Markets and economies can crash, and your investment could suffer.

Each person’s circumstances will vary, and it is difficult to choose wisely unless all of the circumstances are known.  Choosing an IRA account is always a wise decision; which one is best for you is between you and your financial advisor.

Investors are often confused about what they can and can’t do with their Roth IRA.  The Roth is so flexible compared to other retirement vehicles that much is written – sometimes incorrectly – about how the IRA funds can be withdrawn.  Here’s a quick look at which distributions are qualified, and which are not.  For further clarification, see you Roth IRA professional.

» Read more: What’s A Roth Qualified Distribution?

Probate is the mechanism whereby estates are settled.   When you die, the value of everything you own and everything you owe is added up, the debts subtracted from the assets, and the balance distributed to your heirs.  If there is insufficient money to pay all the debts and taxes, your property is sold, generally at auction, to raise cash so that the final bills can be paid.  The process is controlled by an estate executor, appointed by you in your will, or by the probate court if you don’t have a will.

» Read more: Avoid Probate With A Roth IRA

Mark Twain said it best: “buy land, they’re not making it anymore.”  Indeed.  It’s estimated that around 80% of the wealth in the US today is in the value of real estate.  Real estate has always offered an excellent opportunity for long term growth.  Even today, with the real estate market in a slump, there are significant opportunities to be found, and using your Roth IRA to fund your investments can bring a better-than-average rate of return if handled properly.

» Read more: Real Estate Investing With Your Roth IRA

Death & Taxes

The Estate Tax debate rages on in the United States.  Temporarily on hold for 2010, the tax will come roaring back in 2011.  As Presidential administrations change and Congress turns over, no one knows what the future of estate taxes will be.  One thing is for sure:  the government needs money and will take it wherever they can get it.

» Read more: Roth IRA As Part of Your Estate Plan

The ability of a Roth IRA to quickly accumulate earnings for your retirement is legendary.  But sometimes, life throws you a curveball and you find yourself short on cash.  Fortunately, Roth IRA rules allow you to use your retirement funds for other things.  Here are five situations where you may be able to tap into your Roth IRA funds:

» Read more: 5 Things You Can do With Your Roth IRA (Besides Retire)