When is a Dollar Worth More than a Dollar?

When is a Dollar Worth More than a Dollar?

The answer is: When that dollar is in account where is can be accumulated and/or accessed free of taxation. A Roth IRA provides both such Federal income tax benefits.
The tax advantages of a both tax-free accumulation and tax-free withdrawal can be huge and can last for over a century if current rules persist!
Here are two examples of the benefit of Roth accounts:

  1. Roth IRAs can provide especially huge tax savings to a retired person on social security. Withdrawals from regular IRAs are not only directly taxed as income, they can also push the social security income of retirees into being 50% or 85% taxable. The combined taxation of both the regular IRA withdrawals and the social security income can be higher than the regular income tax rates on the wealthiest Americans.
  2. Bequeathing a Roth IRA to a young person can provide incredible long term tax advantages. A 30 year old who builds wealth in a Roth IRA might well expect to accrue tax-free investment income while living for another 70 years or more given the trend towards longer expected life spans. At death, a taxpayer can pass the Roth IRA to a young person in the form of an inherited Roth IRA. The heir can take withdrawals over his or her expected lifetime (perhaps another 80 years or more). The net result is that the dollar placed in a Roth account by a 30 year-old today might be allowed to grow tax free and be withdrawn tax free very well into the next century (assuming that tax laws are not changes to prevent this).

Roth IRA’s offer such powerful tax advantages that they might incentivize young people to temporarily exit the workforce. A Millennial with a low-paying job might wish to take a year off from “the grind” and use the lack of wage income as an opportunity to convert regular IRA holdings to Roth IRA holdings with minimal income taxes due to their temporarily low income. A single person could convert $50,000 from an regular IRA to a Roth IRA while paying only about $5,000 in Federal income taxes. The long term tax savings could be huge. Combined with government-subsidized health care, the incentives to temporarily dropout of the workforce can be powerful. I for one hate to see Millennials given a whole lot more reasons to quit working and quit paying taxes! Many of us are counting on them to pay our Medicare and social security costs.
The disadvantage of a Roth IRA is that contributions to the account are not tax-deductible. People in high income tax brackets are likely better off making tax-deductible contributions to regular retirement plans if they anticipate lower tax rates at retirement. Also, investors should beware of relying too heavily on assumptions regarding future tax rules – which can change suddenly. In other words, wealth should be diversified against the impacts of changes income taxation.
Biltmore Capital Advisors is NOT an accounting firm.  For specific advice regarding taxes, please consult your tax advisor.

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