Mark Freeland said:

or

http://groups.google.com/group/misc.invest.financial-plan/msg/f266b19183823c84
One of your assumptions was different from this. You assumed the same

amount of money, pre-tax, to invest. The amount actually invested in the

Roth IRA was less, because some of that pre-tax money was used to pay taxes.

That's semantic nit-picking. The assumption is that the same amount

of money is available to invest - which means, apples-to-apples, that

one needs to start with pre-tax money. "amount invested" vs. "amount

available to invest". I thought I made it pretty clear that it in

this context, I was defining the former as the latter.

Precision is important, because you had another unstated assumption - that

one didn't have enough pre-tax money to max out the Roth. If one did, as I

That's not an issue of investment performance - but rather one of

investment availability. The effective pre-tax limit on a Roth IRA

is higher than the effective pre-tax limit on a regular IRA because

the limit is applied after-tax on the Roth. But, again, assuming

the same quantity of money is available to invest in both cases

*and* that the quantity will be below the limits, the performance

is otherwise identical.

showed in a followup, the Roth was superior (with all other assumptions as

stated above).

If "superior" means "has a higher limit". To someone who earns above

the income which lets one invest in a Roth, then, I suppose you'd say

the Roth is "inferior" rather than simply "unavailable". Okay by me.

Of course, if "has a higher limit" alone is the criteria, then VAs,

well, let's not go down the VA road...

As someone pointed out in another thread, a (traditional, not Roth) 401(k)

will reduce your adjusted gross income(AGI), which can have all sorts of

That would have been, um, me.

Nits aside, the bottom line is, generally, to all folks who

qualify (ie. have income and it's below the threshold), putting

money into a Roth is a good thing. Having a 401k is a good thing.

Max out both if you can. If income doesn't permit it, then chances

are that income's low enough to do the Roth - as Elle points out

all the time, then, do the 401k up to the match, as much Roth as

one can, then, if there's still funds available, 401k as much as

possible.

The question's a little trickier for folks who can't put

money into a Roth at all (usually due to too much income) - in

which case, if they have a 401k, they should probably max it

out unless it absolutely stinks. But the tricky part is whether

or not it makes sense for that person to put non-deductible

contributions into a traditional IRA, to get a low-cost VA,

to just buy some tax-efficient index fund and put it away.

FWIW, I lean towards loading up the IRA anyway (possibly with

the chance to do a Roth conversion later on), and then manage

taxable investments with an eye towards tax efficiency (ie. by

harvesting losses sometimes, etc).

Should also be interesting as Roth 401k plans start to be

more widespread.

One other thing I was just thinking about recently with respect

to estate taxes - a Roth conversion may also help lower the

value of an estate - by prepaying the taxes on the distributions

from the IRA. If someone has an estate big enough that at the

margin, it's going to get hit with estate taxes (up to 45%),

then every dollar used to pay taxes on a Roth conversion before

death is a dollar less to be taxed as estate taxes - and as

we've discussed above (assuming same rates of return and of

taxation) that has no after-(income)-tax impact on the spendable

amount resulting from the IRA investment.

Contrived example - 25% marginal tax rate (on both owner and his

heirs) and an estate consisting

of (a) a bunch of other stuff (enough to put the estate

up into the realm of estate taxation, say $2million now,

and the 2007 marginal estate tax rate of 45%)

(b) say, $150,000 of cash/investments in a taxable account

and (c) $100,000 in a Regular IRA.

The person dies and the estate pays 0.45 * $250,000 = $112,500

out of the cash to cover estate taxes owed on the IRA and the cash.

That leaves (b) and (c) at $37,500 and $100,000 respectively.

Now, suppose the heir wants to spend all he got in (b) and (c) -

he pays income taxes of $25,000 on the IRA distribution, leaving,

out of the original $250,000, only $112,500 spendable.

Now, suppose that the $100,000 got converted to a Roth - and

the taxes on the conversion, $25,000 were taken out of the cash

in (b). The estate now looks like this:

(a) (stuff)

(b) $125,000 in cash/taxable

(c) $100,000 in Roth IRA

Now the person dies and the estate taxes due on the combination

of (b) and (c) is 0.45 * $225,000 = 101250, leaving the (b) and

(c) looking like this: $23,750 and $100,000 respectively. If

he wants to spend all of it, there are no more income taxes due,

so the whole $123,750 is spendable - ie. since the income taxes

were paid with pre-estate-tax money, he's ended up with $11,250

more to spend. Note that that $11,250 is precisely the estate

tax rate times the income taxes due on that conversion, and

relative to the amounts of money involved here, a huge difference.

Of course, much of that example is contrived - assumption of

the tax rate, for example - a big Roth conversion could bump

into tax brackets - assumption that the heirs cash it all out

and spend it at once - assumption that the heirs have the

same tax rate as the original owner - etc. etc. Nevertheless,

it looks like Roth converions - help with estate tax issues,

even without considering distribution rules.

Ugh. As if this stuff weren't messy enough *before* considering

estate taxation issues.