Thoughts on Roth IRAs

A Roth IRA is a special type of retirement account. While most retirement accounts allow you to save on your taxes today and pay taxes during retirement a Roth IRA works the opposite way. With a Roth IRA you pay taxes on the money before you put into the account in the beginning. However, when you take the money out of retirement as are owed. You don’t have to pay any tax on the original investment because you already paid taxes on it. You don’t have to pay tax on any of the increase because that’s the special advantage of a Roth IRA.

The government likes this type of account because it means they get their tax money now. With a traditional IRA the government doesn’t see any income from taxes until you reach retirement which is often years in the future.

Of course the disadvantage is the fact that you will be taxed at your current tax rate. If you have made a tremendous amount of money this year the traditional IRA may look attractive because it allows you to shelter some of your income from taxes now. However, over all, most people expect taxes to be higher in the future than they are now. If taxes are higher in the future you may be much better off with a Roth IRA even though the tax burden now may seem very high. In addition the government has control over a hidden tax known as inflation. By manipulating inflation they’re able to effectively tax your money without having a tax on it simply by devaluing the currency. If you put money into a traditional IRA and it grows to 100 times its size you will have to pay taxes on all that increase when you go to withdraw the money. With a Roth IRA you will not have to pay taxes on the increase when you go to withdraw it during retirement.

What your retirement account will be able to buy you when you retire is greatly determined by the rate of inflation. While inflation will affect both the traditional IRA and the Roth IRA, a traditional IRA will have to pay taxes on the money. If the government allows  inflation to run unchecked it could push you to an extremely high tax bracket when you go to take the money out. With a Roth IRA you are protected from being put into a different tax bracket based on the withdrawals from your Roth IRA. Depending on what happens in the future this could be a very significant advantage. Even people approaching retirement years may find that the short-term expense of investing in a Roth IRA and needing to pay taxes now may be less than the risk that is mitigated by ensuring that you do not have to pay income tax on the funds when you withdraw them later.

Of course it’s possible the government will change the rules. However, it’s unlikely that they will out and out tax the money you pull out the of a Roth IRA with income tax. It is possible that they will institute some sort of national sales tax or value added tax as is common in Europe. If that happens you will be taxed when you spend the money you take out of your retirement account. However it’s important to note that this is likely to affect people who are taking money out of traditional IRA accounts, 401(k) accounts, 403B accounts, and Roth IRA accounts equally. If the government institutes a tax like this, it is unlikely to have any type of detriment by being in a Roth IRA. The only type of detriment that could be possible is if the government went to an entirely sales tax based system and do away with income tax altogether. In that case the Roth IRA would not perform as well as traditional IRA because you paid tax early and when you went to take the money out the income tax didn’t exist. Of course a sales-tax in lieu of an income tax seems unlikely at this point in time.  Plus the government likes fiddling with taxes too much. A sales tax would require them to stop mucking about  with creating different tax incentives whenever they feel like it.

All in all the Roth IRA seems to be a pretty good  investment strategy. This is especially true if you are investing in an IRA early in your career. There may be more advantage for someone in their 50s to put money into a traditional IRA in order to shelter income and stand lower tax bracket when their money has less time to grow before they will want to withdraw. Even then many people approaching retirement may want to consider a Roth IRA because of the flexibility gives you any amount of protection to give you from future taxes. As life expectancy increases it is possible that someone approaching retirement may have many years for their investments to grow even after they retire and the Roth IRA may present a great way to invest money for the future.

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