I am Kevin McCormally at Kiplinger’s here to talk about delayed gratification. Really I want to talk about individual retirement accounts and how to choose between the traditional IRA and the Roth IRA. With the traditional account you get your tax break up front. Most taxpayers get to deduct what they contribute to an IRA and the IRA’s keeps their hands off your earnings while they grow. Then in retirement all withdrawals are taxed in your tops tax bracket.
With a Roth you get the same tax-free growth inside the tax shelter but there’s no deduction for contributions. But get this; all withdrawals are absolutely tax-free when you pull the money out in retirement. That’s the delayed gratification I was talking about. Another advantage of the Roth is that, if there’s any money left when you die, your heirs get it tax-free. With the regular IRA, they owe income tax on every dime they inherit.
At Kiplinger, we think that Roth is better for most people. Think about it this way, by accepting the deduction for contributing to a regular IRA you accept Uncle Sam as your investing partner. In retirement he’ll effectively demand a return of his initial investment- that money you saved thanks to the up-front deduction, plus a share of every dollar earned inside the IRA.
If you’re in the 25% bracket, the IRS claims 25% of each withdrawal. With a Roth, passing up that upfront deduction buys you tax freedom in retirement. All the money is yours. About the only way you can lose is if tax rates are substantially lower when you retire than when you make your contributions….and really…what do you think the odds of that are?