"Inflation-protected bonds can definitely help in an inflationary environment, but you might wonder what good they'd do with deflation. The answer is that direct-issued TIPS are guaranteed to give you at least their face value back, even if there's deflation over the period of the bond. That won't necessarily help with an ETF like iShares Barclays TIPS Bond (NYSE: TIP), however, so stick to newly issued TIPS."
I've been saying that for a long time. It's nice to see it in an actual news article. For maximum safety, it is best to buy "new" TIPS directly from the government during an initial auction and simply hold them until maturity.
There are still two ways you can lose.
1. Hyperinflation would create an enormous tax burden. The interest coming in would not be enough to pay the taxes on the rising inflation adjusted principal. You are taxed on both each year even though the government doesn't pay you the inflationary gains until the bond matures.
2. Default could see the government simply decide to not pay you back. That's clearly a loss.
However, as I've also said in the past...
If I am financially ruined in TIPS, at least I won't be first.
A disciplined mono-ethnic, self financing economy can deal with deflation much better than a multi-ethnic economy dependent on foreign investment for financing and job growth for an increasing population.
Japan might be able to deal with deflation and a strong Yen for a long period of time. But can the US can deal with deflation and a strong Dollar at all?
During the 1970's, the FED kept interest rates low and attempted to "jawbone" a weakening(inflated) Dollar. Anyone else expect a repeat of the 1970's? when the US standard of living deflated because of a weakening Dollar. Or, will the US somehow be forced to truly defend the Dollar in world markets?
I think we can actually agree to agree now.
"However, I’ve done volunteer income tax assistance for over twenty years; and, in my experience, your hypothetical is so rare it’s not illustrative of the issues. Most individuals receive well less than $20k/year in SS benefits and the top quartile for married couples we typically assist is probably under $30k."
Yeah, I tried to bias the results in favor of the Roth since I did not actually know what the typical SS benefits would be. I figured $50k was certainly at the high end.
It was not my intention to dismiss the Roth out of hand for all people, even for those with modest income and modest savings (although it does get harder to justify for those who will live near poverty in retirement).
I guess what bothered me is that the initial article didn't address the points we are debating. I point once again to...
"At age 60 in 2010, converting to a Roth would cost $28,000 in 2010 taxes and provide post-tax income of $13,070 a year in retirement, compared with $11,681 for a traditional IRA."
Given the $100k retirement savings, the 28% rate to convert, and that the retirement income would be in the $10k range generated, I did have issues with the math. In general, and on average, the traditional IRA seemed the far better choice (his math showed otherwise) for his particular example. Of course, many assumptions would need to be made. It's not like the author bothered to list many of them.
I stand by my heckle of that math, given the limited information we were offered.
However, based on your points I will concede that my later claim "that locking in a 28% tax rate was a bad idea for the majority of taxpayers" could be considered a bit misleading even if true, especially if the majority was just 51% (and as you suggest many don't even have IRAs).
"Over the years I’ve seen countless younger people pay the penalty either because of ignorance or occasionally from pure need of the funds; not infrequently, it results in an additional penalty for underpayment of estimated taxes."
I hear that. You make a great point. I've seen it myself once. I saw a coworker cash out when switching jobs. I don't think it was out of ignorance or need. In my opinion, I think the temptation was just too great. Easy come, easy go. Sigh.
In any event, I'm glad we were able to reach a reasonable middle ground on this. I think we're on the same page now. In fact, perhaps we always were and just didn't know it.
I don't believe that I have ever claimed that Roths should be summarily dismissed as a poor choice, even for taxpayers of modest income, but if I have or even merely implied it when I did not mean to, then I was in error. As you say, I was basing my math on averages. Nobody is exactly average though.
Your initial calculation was correct; their adjustable gross income would be $11,500 which would be wiped out by the standard deduction so their taxable income would be zero. Under your hypothetical, a traditional IRA would, indeed, be better.
However, I’ve done volunteer income tax assistance for over twenty years; and, in my experience, your hypothetical is so rare it’s not illustrative of the issues. Most individuals receive well less than $20k/year in SS benefits and the top quartile for married couples we typically assist is probably under $30k.
My initial posting conceded: “Approximately half the adults in the USA do not pay income tax. I concur that IRAs are inappropriate for the part of that group in the "middle class." That leaves the other half who pay taxes. Most retirees achieve a certain standard of living during their working careers. While their income needs may drop 10-20% when they initially stop working (medical expense becomes a bigger factor as they age), most retirees find that to maintain the standard, they must supplement SS benefits with funds from former employer plans and their savings. A more typical top quartile sourcing of the $60k in your example would be $30k from SS, $20k from savings/employer plans, and (to continue with your hypothetical) $10k from an IRA. If the IRA were a traditional one, using 2009 tax rates, $6,850 of the SS would be taxable, their AGI would be $36,850 and the tax would be $1,600. If it were a Roth IRA, only $1,500 of SS would be taxable, AGI would be $21,500, and the tax $61. Reducing the funding sources to $25k from SS would be even more dramatic: tax for the traditional IRA scenario would be $2,626 vs. $688 using the Roth. Under the latter hypothetical, the effective tax rate on the IRA distribution is just under 20% because of its effect on MAGI.
Your scenario and the way I changed it are both hypothetical and academic. My allocations are anecdotal and can be challenged as atypical. However, I’m not sure using reported averages is any better (the old saw about what’s your average body temperature if one leg is immersed in liquid nitrogen and the other in molten steel?) There is an element that comes into our tax assistance sites yearly who work just enough to maximize EIC payments.
My point (similar I suspect to“responding to’s”) is that Roth IRAs should not be summarily dismissed as a poor choice even for taxpayers of modest income. Young workers usually start out in the lower marginal brackets; and, if successful, work their way into higher brackets. Foregoing the deductibility of a traditional IRA in favor of a Roth while in those lower brackets may be prudent. It gives them an extended period for the non-taxable earnings to compound.
Another consideration you may have overlooked is the 10% penalty for pre-age 59 ½ distributions. For traditional IRAs, the penalty is in addition to the tax and applies to a the entire distribution unless an exception applies or there is a partial after-tax basis in the IRA. For Roth IRAs it only applies to “unqualified” distributions—essentially only the earnings, especially if the Roth is open for five years. Over the years I’ve seen countless younger people pay the penalty either because of ignorance or occasionally from pure need of the funds; not infrequently, it results in an additional penalty for underpayment of estimated taxes.
Good grief. I just said "to low"? It is one of those days.
I would also like to apologize to the message board for correcting corrections on what is generally an off topic conversation.
At least neither of us are flooding this message board with polarizing political commentary or SPAM though. That's something I guess, lol.
Taxable portion = ($50,000 - $32,000) * 50% = $9,000
Total taxable income = $9,000 + $10,000 (from IRA) = $19,000
That's $19,000 taxable in retirement vs. $80,000 taxable while working.
That's what I should have said. I thought the $11,500 seemed to low and it took several rereads to figure out why.
"The traditional IRA owner must take the distribution at 70 1/2 and pay tax on it regardless of whether he wants the funds..."
We just go round and round on this without being able to find some sort of compromise middle ground.
I'm going to try again.
If you are 70 1/2 years old, retired, are still in a high tax bracket even after being no longer being employed, and will not be wanting to tap your retirement account to pay household expenses, then the Roth may be an exceptionally good deal for you.
My examples were not based on such a person though. I was basing my discussions on the roughly $33,000 per year that the typical American worker makes and who generally has a very modest level of retirement savings.
Picture a married couple with 2 workers. Both make $40,000. That's $80,000 in total. Let's say the instant that they retire they receive $50,000 in Social Security instead and say they further augment it with $10,000 from a traditional IRA per year. That brings the amount to $60,000. That entire $60,000 is not taxable though.
"Provisional income is your total worldwide income, including tax-exempt income, plus half of your Social Security benefits."
Provisional Income = $10,000 + 50% * $50,000 = $35,000
"If you provisional income is between the base amount and the additional amount, then half of your Social Security benefits over the base amount are taxable."
Taxable portion = ($35,000 - $32,000) * 50% = $1,500
Total taxable income = $1,500 + $10,000 (from IRA) = $11,500
That's $11,500 taxable in retirement vs. $80,000 taxable while working.
I am suggesting that the former will more than likely see a MUCH lower tax rate than the latter, even if marginal tax rates do rise across the board.
This is how it works to the best of my understanding. I could be wrong though. If I am, which I very well could be, then please explain to me how I am wrong as it relates to this specific example.
"I don't really see what the point would be though."
The traditional IRA owner must take the distribution at 70 1/2 and pay tax on it regardless of whether he wants the funds and even if the extra income adversely affects the rest of his tax return. Failure to take the distribution triggers a 50% penalty. The Roth IRA owner has no such obligation. Life expectancies at age 70 are approximately 12 years for males and 16 years for females. Older Roth IRA owners can allow their balances to compound undepleted by taxes until they die. After death, withdrawals are mandatory based on age of the beneficiary. If the beneficiary is a generation or more removed, the compounding can continue for an extended period. Generation-skipping beneficiaries can also be used by traditional IRA owners, but the distribution must be grossed up to pay any income tax owed (or taken from some other source which would diminish that principal.) Furthermore, if the distribution exceeds the "kiddie tax" threshold, the tax owed will be computed at the parents' marginal rate.
"As for the Social Security angle, you assume wrong. The Social Security rules are quite kind to those who earn a high amount of income for 10 years or so and worked for 20 overall. It's similar to someone who worked 40 years at a low income."
That may be true if the 10 years are between ages 51 to 60 or later. In calculating retirement benefits, earnings are indexed "to reflect the general rise in the standard of living that occurred during his or her working life." The indexing system favors earnings closer to "normal retirement age." See Case B in the benefit calculation examples at:
Case B is an example of a person who has earned at or above the maximum taxable amount in each year. Earnings for 1970 would count for only $44,948 whereas 2009 earnings count for $106,800. (1970 earnings are not used since the worker's career exceeded the 35 year maximum considered for the calculation.)
Because of the way the "bend points" work, a low wage earner with a 35+ year career receives a higher percentage of his earnings as a retirement benefit than someone who is eligigble for benefits based on years of earnings that exceed the taxable maximum.
"The point might have escaped you. At 70 ½, you must withdraw 3.65% of traditional IRAs’ total balance and 0% of the Roth. The percentage increases yearly until death."
My $100,000 example was pulling out 10%, or roughly THREE times that amount. Pulling out less than that would simply ease the burden. I would be more than happy to do another example based on the minimum distribution tables. I don't really see what the point would be though.
"Could discrediting them because they don’t meet your private situation or because you don’t understand the context in which they might provide value or flexibility be part of the “ whole ‘elitist snob’ thing?”"
I grew up middle class in small farming community. I drive a 14 year old Camry. I live a frugal lifestyle. There are no maids to clean our toilets. You'd never guess if you met me on the street that I had any money at all. I certainly don't dress like it. I did not call you an elitist snob by the way. It was not you that used the "meager" and "decent" words to heckle my $100,000 retirement savings example. If I was really an elitist snob, I would have used my retirement savings as the example. Right? Perhaps something not quite so "meager".
As for the Social Security angle, you assume wrong. The Social Security rules are quite kind to those who earn a high amount of income for 10 years or so and worked for 20 overall. It's similar to someone who worked 40 years at a low income. If I was writing the rules, I'd certainly penalize me more than the government does.
I am eligible by the way. That's not why I don't think I can expect much Social Security though. Here's what it says on my statement.
"The law governing benefits amounts may change because, by 2037, the payroll taxes collected will be enough to pay only about 76 percent of scheduled amounts."
Combine that with the massive amount of debt we have taken on in the last decade and I'm just not all that optimistic about future Social Security benefits. If we stay on the path we are on, this country will bankrupt itself long before I get my first check. Some would argue that we already are bankrupt, but just don't realize it yet.
"If she has any savings in pre-tax accounts and hasn’t exhausted her standard deduction and personal exemption, she should consider Roth conversions up to the top of the zero percent bracket."
I would completely agree with you on this. Unfortunately, like many other Americans she has zero savings. She'd be bankrupt many times over if I hadn't helped pay her medical bills and other expenses. I support her though, and have cut my spending to the bone.
Look. I'm really not trying to pick a fight with you. I am simply arguing that there are many, many American workers/families with very small retirement savings that would probably be better served using a traditional IRA. If you are dead broke in retirement, then you probably won't pay much taxes, if any. Therefore, it may not be the best of plans to prepay taxes at a higher rate. That's it. If my judgment is clouded, it may be that I am overestimating just how many people will be broke in retirement. I fear that I might even be. It's a race between life expectancy and savings, because the era of making money off of money seems about over.
"From these studies, its clear that many American families are going to need to drastically increase their savings, work longer, or significantly decrease their expenditures in retirement if they hope to make ends meet." - ebri.org
According to the latest Fed's Flow of Funds report, the net worth of households and nonprofit organizations has declined $9.8 trillion since peaking in 2006.