Risky Roth IRAs.Comparing the risks of Roth IRAs Roth IRA An individual retirement plan that bears many similarities to the Traditional IRA. Contributions are never deductible, and qualified distributions are tax-free. A qualified distribution is one that is taken at least five years after the taxpayer established his/her first versus traditional IRAs means weighing a future unknown benefit against a certain one. Traditional IRAs have immediate tax savings. Roth IRAs, on which taxes are prepaid, may have a future benefit that is less than the prepaid tax. Specifically, there are three risk factors for Roth IRAs. The first risk is the possibility that the IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. or federal income taxes may not exist in the future. Although you may be smiling (or, perhaps, even laughing), bear in mind that in June the House passed the Tax Code Termination Act, which would eliminate the current tax code (except for Social Security payroll taxes) on December 31, 2002. In addition, a grass-roots group of taxpayers called the Citizens for an Alternative Tax System Citizens for an Alternative Tax System (CATS) is a national tax reform public interest group in the United States. The organization states that they were established to solve "very serious problems caused by the United States' unfair and destructive income tax system", which they (CATS) is pushing for the Schaefer/Tauzin National Retail Sales Tax sales tax, levy on the sale of goods or services, generally calculated as a percentage of the selling price, and sometimes called a purchase tax. It is usually collected in the form of an extra charge by the retailer, who remits the tax to the government. Act. This act would replace income tax with a sales tax. The second risk is the possibility that money received from a Roth IRA distribution might not be subject to tax at all if, when it is combined with other earnings, the total amount of income has not reached a taxable level. The third risk is the likelihood that the present value of the prepaid tax (the cost) of a Roth IRA may be greater than the present value of the future tax savings (the benefit). For example, if a 40-year-old invests $2,000 yearly in a Roth IRA for 25 years (assuming a 28% tax bracket Tax Bracket The rate at which an individual is taxed due to a particular income level. Notes: Each income class is taxed at a different level. Generally, the more you make the more you are taxed. ), the prepaid tax of $560 per year has a present value of $5,083. Assuming a 10% growth rate, the fund will grow to $146,694 in 25 years. Still assuming a 28% tax rate, the tax savings with a Roth IRA (if all funds are withdrawn in one lump sum Lump sum A large one-time payment of money. ) will equal the $146,694 times 28% to a total savings of $41,074. The present value of $41,074 discounted for 25 years at 10% is $3,791. The net present value of a Roth IRA in this case would be a negative $1,292 ($5,083 cost minus $3,791 savings). Observation. Clients should know that, unlike a traditional IRA that provides a certain immediate benefit, the benefit of a Roth IRA might be zero. The greatest risk of a Roth IRA, however, is that the present value of the prepaid tax could be greater than the present value of the future tax savings. W. Terry Dancer, PhD, associate professor of accounting, Glen Jones, JD, assistant professor of law, and James Washam, PhD, assistant professor of finance, Arkansas State University Arkansas State University, at Jonesboro; coeducational; chartered 1909; named State Agricultural and Mechanical College, 1925–33. In 1933 the school became Arkansas State College, and in 1967 it achieved university status and adopted its present name. . |
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