Retirement Day!

So, Brian still doesn't totally get the Roth versus Traditional IRA argument.  He thought that this article might be worth reading.

http://www.getrichslowly.org/blog/2011/04/06/all-about-asset-location-how-to-make-the-most-of-your-accounts/

This article introduces a new idea into the traditional versus Roth retirement account which is to split the types of investments into each of the accounts.  We'll get to that in a minute.  First a quick example:

$1000 for a traditional account and you are taxed nothing now.  You make 10x dollars and end up with $10000.  You get taxed at 20% in the future.  You get $8000.

$1000 for a Roth account and your taxed at 20%.  $800 goes into investments.  You make 10x dollars. You get $8000.

In both cases you end up in the same place assuming tax brackets go nowhere.  Looking at the past shows that the tax brackets haven't held for long periods of time.  It appears that based on the "Partial History of Marginal Income Tax Rates Adjusted for Inflation" section of http://en.wikipedia.org/wiki/Income_tax_in_the_United_States that we are at a relatively low point for taxes.  Based on where the US stands now, both economically and with the potential results of the 2012 election that taxes will to some degree go up.

For a simple way to look at it:  if you have a lower tax bracket in the future, then traditional wins.  Higher taxes in the future, then Roth wins.

With a Roth account, you know what you will have in the future is what is in your account.  With the traditional, you will lose some percentage of you money in the future, but it isn't clear what that will be.

To add some more complexity, a question came to mind.  Does my deduction drop me into a lower tax bracket?  This will make a difference as well.  Try putting enough into a traditional to get you in a lower tax bracket and then put the rest into a Roth!  Not sure if this would actually work for anyone, but it is a neat thought experiment.

The article above has an interesting premise.  Safe investments go into traditional accounts.   Tax protected investments (muni bonds) don't need the tax benefit of no future taxing.  Roth takes the high risk, high reward investments since the initial funds were already taxed.  One still has to take bad situations into account where the money that you thought would make you 3% makes you 10% and the high risk gets you a big loss.  This means that you are still trying to predict the future.

The article ends with the normal suggestion of looking at what tax bracket that you'll be in in the future. That isn't necessarily easy to predict.  What determines what tax bracket that you'll be in when you retire?  Income is dividends, interest, and taxable distributions.  Your output at retirement is dependent on how old you are when you retire.  If you have an assumption that you won't live long, then you can burn it all in 6 months and it will be taxed at a high bracket.  If you need it to last, then your withdrawal rates may be small putting you in a lower tax bracket.

Here is something extra for fun:

How do you make 100million into a Roth IRA?  If you put 5k a year into an account that makes 20% starting at the age of 20 and retiring at 65, you will have ~91M.  If you start one year earlier, you'll end up with 109M.  That's a lot of bonus for one year!  The lesson:  you need to find a high yield investment, go back in time, and get your butt in gear!

Profit!