How to evaluate Roth IRA vs TIRA in this case?

[Tom52]

I am no where near as savvy as many of you here when it comes to investing so maybe this is a silly question. Both DW and I have income from w*rk. I have a 401K thru my employer but DW only w*rks PT with no benefits. For tax year 2011 she is allowed to make a tax deductable TIRA contribution $6,000 which would give me about $1,500 additional tax return this year. I am not eligible for a tax deductible TIRA so the last few years I have invested my $6,000 in a ROTH IRA (Vanguard Wellesley).

My question is, How do you evaluate whether or not it is better to invest DW's $6,000 into her TIRA vs. investing in a new Roth IRA and fore go the $1,500 tax savings now for possible tax advantages in the future? Either way the $6,000 would be invested in Vanguard Wellesley.

If it has a bearing, DW is soon to be 58, we would like to retire in about 3 years, and we would not need this money before she reaches SS retirement age 66.2 months, maybe even later than that.

what needs to be considered to make the best educated decision?

Tom

 

[panacea]

The most important important factor IMO is your current income tax rate vs. your projected tax rate when you withdraw the money in retirement. If you're at 25% federal tax bracket now but expect to be in the 15% bracket once retired, you're likely better off taking the deduction upfront. No sense in paying more taxes now only to save less taxes later.

 

[Alan]

The most important important factor IMO is your current income tax rate vs. your projected tax rate when you withdraw the money in retirement. If you're at 25% federal tax bracket now but expect to be in the 15% bracket once retired, you're likely better off taking the deduction upfront. No sense in paying more taxes now only to save less taxes later.

+1

It's almost impossible to predict future tax rates, but for 2012 the 15% band goes up to $70,700 taxable gross (after deductions and credits) for married couples. It looks like the OP's marginal rate is 25% now so I would not do a ROTH. You can always do a ROTH conversion later if you want, should your income be in the 15% band.

 

[Koolau]

what needs to be considered to make the best educated decision?

Tom

Clearly, there are a lot of unknowns here. What will be the future tax rates (anybody here betting they will go down?) How much will your tIRAs and 401(k)s grow to by the time you have to pay RMDs? This is very difficult to estimate (heck, they could go down in value - think of all the taxes you will save) Will you move to a higher or lower taxation state after you retire? So, figuring what your future tax bill will be is problematic at best.

Alan's suggestion is probably the most conservative approach.

Just a couple of other wrinkles to consider: When will your income go back UP during retirement due to taking SS? Don't forget that SS can (probably will) affect your tax bracket - especially when added to your RMDs. So, when you take SS may depend upon when you do your Roth conversion(s). IOW, you probably should only do a conversion in the window between when you both retire and when you begin your SS.

Will you have enough after-tax money set aside if and when you make Roth conversions to pay the extra taxes then? Paying the taxes with after-tax money gives you a bump up in the value of your Roth over its tIRA equivalent.

Honestly, I love Roths so much that my inclination would be to do the Roth now unless you can pretty convincingly show that your tax RATE will go down in the future when you retire. Roths have flexibilities that tIRAs don't have. Yes, you can convert later, but that also starts the 5-year clock again on when you can withdraw proceeds (not the original investment).

I didn't mean to muddy the waters, but I hope I did give a few things to consider. Oh, and YMMV.

 

[MichaelB]

If you can afford the Roth but think your tax rate will be lower in the future, why not use the tax deferred IRA now and also invest an additional amount equal to the tax saved, in a taxable account. If your future tax rate ends up higher at least you will have part of the tax liability covered.

 

[ziggy29]

The most important important factor IMO is your current income tax rate vs. your projected tax rate when you withdraw the money in retirement. If you're at 25% federal tax bracket now but expect to be in the 15% bracket once retired, you're likely better off taking the deduction upfront. No sense in paying more taxes now only to save less taxes later.

Agreed with this, and I'd add a little more. I would personally err on the side of marginal tax rates rising a bit in the future (I think it's a fairly safe bet they won't drop from the current levels). So if I thought I had 25% taxation today but in the 15% bracket for retirement, I'd probably choose the TIRA if I could since I don't think the 15% bracket will rise to 25% or more.

But if I thought I was in the same bracket now and in retirement, or if I thought the retirement bracket would be only slightly lower (such as 28% now versus 25% in retirement), I might be more inclined to go the Roth route.

In my planning (age 46) I personally assume tax brackets will be 3-5% higher in 15 years compared to now (based on nothing more than gut feeling). But I also assume we'll be in what is now the 15% bracket in retirement compared to 25% today, so the tax deduction today still makes more sense even if the 15% bracket rises to (say) 18-20% in the future.