USA Today has an article lambasting the idea of changing IRA's which they say is to be in the tax plan to be released today. The change would reduce the amount of a current contribution that could be deductible but would increase the amount that could be contributed after tax into a structure like a Roth IRA. Right now, you have a choice. You can contribute to a traditional IRA and get a deduction. For example, you put in $3000 and you deduct that off your income before taxes. When you take money from the IRA, however, you pay taxes on the full amount. Alternatively, you can pay the tax now and put that same $3000 in a Roth IRA. You get no current benefit, but when you take the money out, it is tax free. Since the money grows tax free over time in either case, you will likely be taking out much more than you contributed in the first place.
The rumored change is that IRA's will be changed to being all Roth IRAs from here on out. USA Today says that this will reduce contributions because the tax incentive won't be there and that will mean people will have less in retirement. That sounds good, but it doesn't finish the story. USA forgets that the money in traditional IRA's is subjected to tax as it is withdrawn. In our example above, let's say that the cash in the IRA quadruples over time. The person who put money in the traditional IRA can take out $12,000, but he or she has to pay tax on it when withdrawn. That might leave $9,000. If someone instead used the Roth, the full $12,000 is available with no tax. So let's say though that the switch to a Roth means the contribution gets reduced to $2500 after tax. That person would have $10,000 at withdrawal time but no tax will be due.
These are just numbers used for illustration purposes. It may be that in the aggregate, the after tax effect in the future will mean this change lowers available cash or raises available cash. My point is not that one or the other will happen. Who knows after all what the tax rate will be in thirty years. My point is that one cannot analyze this issue without considering the tax due on withdrawal, the way USA Today has done.
UPDATE: The GOP released their tax plan. Despite what USA Today said, the plan makes no changes to the rules regarding retirement accounts. So will USA Today now issue a statement that says, "nevermind"?
The rumored change is that IRA's will be changed to being all Roth IRAs from here on out. USA Today says that this will reduce contributions because the tax incentive won't be there and that will mean people will have less in retirement. That sounds good, but it doesn't finish the story. USA forgets that the money in traditional IRA's is subjected to tax as it is withdrawn. In our example above, let's say that the cash in the IRA quadruples over time. The person who put money in the traditional IRA can take out $12,000, but he or she has to pay tax on it when withdrawn. That might leave $9,000. If someone instead used the Roth, the full $12,000 is available with no tax. So let's say though that the switch to a Roth means the contribution gets reduced to $2500 after tax. That person would have $10,000 at withdrawal time but no tax will be due.
These are just numbers used for illustration purposes. It may be that in the aggregate, the after tax effect in the future will mean this change lowers available cash or raises available cash. My point is not that one or the other will happen. Who knows after all what the tax rate will be in thirty years. My point is that one cannot analyze this issue without considering the tax due on withdrawal, the way USA Today has done.
UPDATE: The GOP released their tax plan. Despite what USA Today said, the plan makes no changes to the rules regarding retirement accounts. So will USA Today now issue a statement that says, "nevermind"?
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