VUL and EIUL is not a retirement plan. It’s a life insurance with the supplement to save money. Make that clear to the people reading this. Oviously the money of an EIUL and VUL become taxable because when the people get their money they get all of it out, and therefore the Life insurance cancels. Make that clear to the public also. However if not all the money is taken out the policy doesn’t get canceled and therefore you cannot get taxed for that money because the policy still exists!!!

ALERT ON TAXING OF IRA/401K WITHDRAW! :

>and it earns $20,000, you retire and start taking it out, you have to pay tax on the 25,000. AT 25% that’s 6,250

NO!!!!! You would most likely pay much less. Read on…

Most people can basically ignore the comments about the $15,500 limit being an issue. That would be $20,500 or more with an IRA. Most people can’t even afford to contribute the IRA minimum of $5000 and are burried in credit card debt.

The thing that bothers me about this article, like many other articles offering advice on this topic, is that the author repeatedly hangs on the issue of the tax bracket at contribution vs retirement as being the key determining factor as to whether you should invest in traditional vs Roth, and he implies that the withdrawals in a given year are taxed fully at the marginal tax rate. There’s no mention in there that anyone making a withdrawal would get a tax deduction, exemption, or have to pay into lower tax brackets of a progressive tax scale before paying anything at the marginal rate. Some of the responses indicate that was their take also, such as, “you retire and start taking it out, you have to pay tax on the 25,000. AT 25% that’s 6,250.” That’s not true! Some people only have to pay at the marginal rate on $1 of their income.

The author also stated that if you knew your tax bracket at retirement, it would simply be a matter of using the calculator he links to, but I found two BIG problems with that calculator. When doing the direct comparison in the graph of Roth vs Traditional, that calculator assumes that if you have $5000 of gross income to invest, that the same dollars go into both funds, but we know the Roth investment would be considerably less due to the initial tax that comes out of the $5000. And the bigger problem with the calculator, is just as I was saying about that article, is if you enter 15% as the marginal tax rate in the calculator, it applies that tax rate to the entire final total of the traditional investment, as if deductions and the progressive tax structure didnt exist, when we know it would likely be a much lower percentage, almost certainly for most working/middle class Americans. Haven’t anyone heard of the effective or average tax? That’s what is really paid in a given year, not the marginal tax rate. We dont know what the future holds, but we should at least apply current facts and trends in our calculations rather than applying the “marginal tax to all” philosophy this article and calculator provides, which is very unlikely to be our future tax structure. Of course, there are other things to consider, primarily if someone is able to invest more heavily, will hit the yearly contribution caps, and will have higher forced distributions during retirement, and whether someone has other sources of income. I dont think that applies to most people, especially the working & middle class, so when it comes down to the pure numbers, and the people most needing advice, the traditional IRA is the better choice.

This guy here gives better than average advice. The thing that is not taken into consideration is the moneys worth or buying power. You can’t add 2008’s $5000 to the $20000 appreciation it might make in 30 years. By then that $25000 might only buy a weeks groceries. Don’t forget that inflation eats on your investment just like it does on your day to day income. A regular 401k is a tax deduction, if you turn it down now (any part of it) you will never have another opportunity to save those 2008 dollars. Who knows what the tax rate will be in coming years, but one thing is pretty sure, inflation will keep chugging along, eating away at your moneys buying power.

Roth or Regular ? If you put $5000 in a regular IRA (saving 1500 in tax that year)and it earns $20,000, you retire and start taking it out, you have to pay tax on the 25,000. AT 25% that’s 6,250…leaving you with 18,750 + the 1500 you saved when you made the deposit…total $20,250.
If it is a Roth you put in $5000 and it
earns 20,000 and it is tax free when you pull it out, then wouldn’t you have 25,000 less the 1500 you paid in tax on the original investment or $23,500 ??? $23,500 Roth vs $20,250 Regular ??? Is that correct ???

If you like sheltering your investment gains from taxes, you should put as much money as you can into a 401k/IRA REGARDLESS of whether it’s a Traditional or a Roth style.

If you are able to set more aside for savings, you can shelter more money using the Roth than with the Traditional because you pay the taxes before you count how much you’re allowed to put away.

Choosing one or the other based on tax rates is an attempt to guess whether your future tax rate will be higher or lower than your current tax rate.

In my opinion, I doubt that we’ll ever have tax rates as low as they are now. Another reason I use the Roth.

The calculations are leaving out one important factor. The difference between the $20,667 necessary to fund the ROTH vs the $15,500 to fund the IRA. You still have the $5,167 to invest. What if you put the $15,500 into a traditional retirement account and the $5,167 ($20,667-$15,500)into a taxable non retirement account and let it grow. What is the difference in the end balances between the two accounts when you retire? What are the results for a variety of different combinations of IRA’s and Roth accounts?

>Because for someone in the 25% tax bracket, $20,667 before taxes is the same as $15,500 after taxes.

Wrong! This math would cause MANY people to make the wrong decision. I’m in the 25% tax bracket, and I pay far less than 25% of my income in taxes. You totally forgot about the standard deduction, personal exemption, and the fact that there are 10% and 15% tax brackets that are paid into before ever hitting the 25% bracket. Heck, it’s possible that someone in the 25% tax bracket may only be paying a very small amount of tax in that bracket, and most of their income could be deductable or at 10% to 15%. But dont feel bad, Suze Orman gives the same bad advice as have other so-called experts on this topic. Amazing that no one commenting here else caught this. It changes everything!

What about compound interest? Let’s say I contribute the max for 30 years with a rate return of 9%. Compounded this is aprox 2.3 million taxes pre-paid with the Roth.

Now with 20,667 the number you suggested as the equivalent for a 401(k) if you could contribute this much compounded it is aprox. 3 million.

Now here’s the rub. You need to pay taxes on that 3 million dollars you earned when you retire. Taxes at a rate of 25% ends up being 750K for that 3 million you earned.

In the end you are left with 2.25 Million if you use the 401(k). This is still less then the Roth in addition if you end up in a higher tax bracket they take out more.

If you contribute the max and you can compound that interest for 30 years wouldn’t you suggest to go with the 401(k) Roth?

This said isn’t the Roth a better option? You’re not taxed on your compound interest.

Please correct me if I’m wrong.

Another option would be to invest in the Tarditional 401k and then open a Roth IRA (Income limits apply). If you open a Roth IRA before April 15th, you could contribute $4000 to last year and $5000 to the 2008 year.

- Just a thought…

What about ROTH IRA contributions? Does the contribution amount to this account effect what distribution is best for the traditional vs ROTH 40lk? i.e., should the distribution be different for someone who maxes out the ROTH IRA contribution vs someone who does not or is this irrelevant to the discussion?

Yes, many of us like to try to further optimize these choices. Along the point made by Jeff from Greensboro, but taking it farther, I put enough into the traditional 401k so that I hope to “fill up” my income in the lower tax brackets. Then I put the rest in the Roth.

Other considerations include phase-outs for child tax credits, etc. Since the traditional 401K lowers your AGI, that is part of the equation also.

Is it correct that if you invest in a Roth 401K you can withdraw your contributions(not your earnings) anytime without the 10% penalty. I was thinking that the Roth would be the better option for those of us who plan to retire before 59 1/2.

I would go with the regular 401k all the way. At least with the pre tax your taking that money that would go to taxes & investing it. Which over time could pay for itself. Thus when you withdrawal the taxes have already paid for themselves. Plus not paying the taxes now your not paying taxes for a retirement you might not get too or might not fully use.

It may also be a good idea to check whether company matched funds are added into a seperate traditional 401(k), company stock, or your Roth 401(k).

Glenn Davis,
The column is correct if you assume you tax rate at retirement is the same as now. He is comparing after-tax dollars of both options. Investing $7,750 in a Roth will have a higher after value at retirement than investing $7,750 in a regular 401(k).

I thought the maximum contribution to a roth IRA is $4000 for 2007 and $5000 for 2008? Even if you like the roth idea you can’t contribute $15,000+ to it.

The main point is about tax diversification and flexibility in retirement, as well as that–in effect–you can save more via a Roth 401(k) (assuming that tax rates will be higher in retirement, which–given the historic lows now–they almost certainly will be). When you divvy money into two pots–the regular “I’ll avoid taxes now and pay them later” 401(k) and the Roth “I’ll pay taxes now and avoid them later” 401(k), you’ll have options retirement about how to best withdraw that money while avoiding taxes.

In terms of the Roth 401(k) allowing you to save more money, Updegrave is right. In effect, when you put money into a regular 401(k), part of the money is for you and part is for the government; that is, you’ll have to use some of your withdrawal to pay the taxes on your withdrawal. By contrast, every dollar in the Roth 401(k) is for you. The trade off? You’ll give the gov’t its tax money now. But–as mentioned–since the gov’t taxes us at historic lows now, you’ll likely pay the gov’t less now with the Roth 401(k) than you will later in retirement with a regular 401(k), after the gov’t has no doubt raised the tax rate.

In either case–whether taxes are raised or lowered, and whether your tax bracket goes up or down–you will likely be better off playing it safe and investing in both types of accounts.

Have one simple comment. if you are in the highest tax bracket that you anticipate put it all in the conventional because if at some future date you are in a lower tax bracket you can move from the conventional to a roth by paying the tax at that time. and if you are like me and take a year off part of it is tax free!

I think a big part of this discussion that was only touched on is “peace of mind”. If you think into your future when you’re age 70, do you want the freedom to know that the $500,000 (or whatever number) is tax free and you can withdraw on it or just leave it alone (Roth 401k, no RMDs); or would you want to contend with having to withhold taxes everytime you want to have money, and being forced to take money out of that account every year (401k, RMDs).

I personally like freedom. Doing the calculations every now and again to see which is more beneficial is worthwhile, but having a plan and following it through (by consistently contributing and rebalancing) is more than most people do.

There’s no need to over analyse these things. Live below your means, save in a way you understand, and be happy.

To Glenn: I believe his point was that if you choose to contribute $7,750 into your roth 401(k), you end up taking $10,333 off of the money you recieve in your paycheck because you’re still paying tax on that money and you need to net $7750 - not that you’re saving more.

Also, one thing to keep in mind is the taxability of any match your employer may be making. If I contribute as a Roth contribution, and my company matches dollar for dollar - I have a 50/50 mix of pre and post tax dollars due to the fact that the company match is pre tax money.

If you are in a middle income range, and receiving social security, each dollar pulled from a traditional IRA makes 85 cents of social security taxable. This will put your marginal tax rate over 50%.

I do not agree with the statement that the Roth and the 401K are mathematically equivalent (assuming tax rates stay the same). The roth 401K is taxed at your current marginal tax rate, say 25%. The traditional 401K is taxed upon withdrawal and is likely to be the majority of your income during retirement (maybe some social security also). That means the tradional 401K will be essentially taxed at an effective tax rate. Under the current tax structure, the maringal tax rate for a single person earning up to $77100 is 25%. For that same person to have an effective tax rate of 25%, their income would have to increase to ~$165,000. Unless your income is going to increase drastically over your career, the traditional 401k is likely your best bet.

In your column you said:
Divvying up your contribution on a 50-50 basis might seem like a logical place to start. But remember: You’re dealing in pre-tax dollars with the regular 401(k) and after-tax with the Roth. So if you were to contribute the $15,500 max and put 50% in each option—$7,750 in the regular 401(k) and $7,750 in the Roth—you would actually be favoring the Roth option because $7,750 after-taxes is the equivalent of $10,333 before taxes if you’re in the 25% tax bracket.
This does not make sense. Comparing what the pre tax dollars would be only matters with regard to what you are saving from your taxes. $7,750 in Roth is not the equivalent of $10,333 because you do not have the pre tax deduction for the Roth. Your not saving more because you paid tax on the money. Its just the reverse.

One little comment to add - The Roth does not require minimum withdrawals starting at 70 1/2. A young person starting funding a regular 401K could easily end up in a high tax bracket just because of minimum withdrawals

one issue I have never seen addressed re: Roth 401Ks, is the fact that the Tax Rebate recently announced is based on your Taxable Income. If there are future rebates, those who use a Roth might lose some of their rebates. Also, Itemized deductions are phased based on AGI, so it is more complicated than the author states.