Roth IRAs

Fundamentals of Market Investing by Adam J. McKee

Most folks saving for retirement do not ever think of tax risks.  It is almost as if we have resigned ourselves to be poor in retirement, and the one advantage of poverty is a low tax liability.  A Roth IRA works the opposite of a regular IRA; you pay taxes on the money you put in the IRA, but you do not owe any taxes on the profits you make and withdraw in retirement.  This may sound backward, but it can have some tax advantages for high net worth individuals.  It can also have some great benefits if you believe (as I do) that taxes will go up in the future.

All of our much-touted tax cuts of late came with a bigger than ever spending bill.  (If the US Government had common stocks, no value investor would even consider owning it given the state of the balance sheet).  At some point, we will have to start paying those debts, and that money has to come from taxes.  If this forecast is correct, then you may well be better off paying those taxes today than in the future when the rate is much higher.  Our strategy for all sorts of risk has been to diversify it away, and I see no reason that you should not diversify away some tax risk as well.

Once you reach retirement age (59.5), there are no limits on how much you can withdraw from your IRA.  This means that if you want to withdraw enough to buy a cabin in the Black Hills as your retirement home, then you can do so without paying taxes on the otherwise high taxable amount.  This logic holds for any very large purchase you wish to make early upon retirement.  Recall that regular IRA withdrawals are taxable as regular income.  Therefore, if you take out $300,000 to buy your dream condominium on the beach, you will be taxed on that amount at a very high tax bracket.  The Roth is a great vehicle with which to save for that awesome thing you’ve always wanted, no matter what that thing is.

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