Answers to 5 Burning 401(k) Questions

To Roth or not to Roth, that is the question

There are many benefits to a Roth IRA. However, for the longest I failed to see the primary benefit of the Roth IRA over the Regular IRA. When removing funds after 59 1/2 from a Regular IRA you include the gains as ordinary income. If you put the same money in a non-IRA account and have capital gains, then the tax rate is less for long term capital gains. Since the gains from the Roth IRA are not taxed at all, the fine point of ordinary income versus long term capital gains goes unnoticed.

In 1998, when we were first given the option of converting Regular IRAs to Roth IRAs, it appeared to be a simple issue of which tax bracket would be higher, the current or when you removed the assets. The investments would be equivalent whether you chose an IRA or a Roth IRA if you assumed you would be in the same tax bracket. If anyone is interested, I'll be happy to put down some simple formulas to show that fact, but to keep from scaring you away ...

The Roth IRA wins if and only if (assuming the same tax rate) you are able to transfer the full amount of your Regular IRA into the Roth IRA. This requires that you use different funds (your regular savings) to pay the taxes, since the conversion requires you to pay taxes on the full amount transferred. Thus, you essentially move your regular savings over to the Roth IRA and all future gains will be untaxed. If you do this you will be way ahead. We would have to assume what the tax brackets would be to know each individual case, but if possible, just max the Roth and don't worry.

John M. Alexander of TX @ Jun 08, 2008 23:29:04 PM