posted: Feb. 22, 2008 @ 11:00a
Southpaw75 said:So should I invest $5,000 (after tax money) in a trad IRA which is deductible and I would see a net gain of $1250 in 2007 taxes (assuming 25% tax bracket) but I would have to pay tax upon withdrawing at retirement age
Or should I invest the $5,000 in a Roth IRA which nets me no tax break for 2007 but would grow tax free?(If you invested $5000 in a traditional IRA and got a deduction, it wouldn't be after-tax money anymore.)
This is a very fundamental question. There are several factors to consider, but the most important one is what you think is going to happen to your tax rate in the future. I know that nobody knows what the future holds, either for them personally or for our tax policy, but whatever you do, you're really betting on that.
Are you in the 25% bracket now because you're temporarily unemployed (or medium-term, to stay home with kids, for example)? Do you expect to go up to the 35% bracket soon and stay there? If so, you probably want a Roth IRA, so that your money is taxed at today's 25% instead. Conversely, are you right at the peak of your earning power now, and expect to be in the 15% bracket in retirement? In that case, you probably want the traditional IRA, because it's worth paying 15% later to get a 25% deduction today.
If you think you're staying at the same rate, or not changing much, I would go with the Roth for a number of reasons (ability to withdraw your contributions without penalty, ability to let the money sit instead of having to take withdrawals when you turn 70 1/2, ability to effectively contribute more since $5000 after tax is "really" more money than $5000 on which you'll have to pay tax later...). But if you are confident you'll ever be in a lower tax bracket, even temporarily, I would go with the traditional and try to convert later.
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