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.
