Traditional IRA - Advantages

Advantages

• The main advantage of a Traditional IRA, compared to a Roth IRA, is that contributions are often tax-deductible. For instance, if a taxpayer contributes $4,000 to a traditional IRA and is in the twenty-five percent marginal tax bracket, then a $1,000 benefit ($1,000 reduced tax liability) will be realized for the year. Because qualified distributions are taxed as ordinary income (the taxpayer's highest rate), the long-term benefits of the traditional IRA are only comparable to those of a Roth IRA (whose qualified distributions are tax free) if the current year tax benefit ($1,000 above) is reinvested, or if the pre-tax amount going into both is the same.

• Also, if a taxpayer expects to be in a lower tax bracket in retirement than during the working years, then a traditional IRA offers an increased incentive over the Roth IRA.

• Even if the taxpayer is in a comparable tax bracket in retirement, there may still be an incentive over Roth IRAs: When money is saved during the working years, only a small amount is contributed per year, which is taxed (Roth) at the taxpayer's top (marginal) tax bracket. During retirement, taxable income will likely consist largely of retirement account distributions; due to the progressive tax system, parts of the distribution will be taxed at lower tax brackets.

• Another advantage of a Traditional IRA is that the taxpayer gets the tax benefit immediately.

• With the Roth IRA, there may be a risk that over the next several decades Congress will decide to tax Roth IRA distributions; or that a national Value Added Tax will be imposed on purchases. Either alternative would subject the Roth beneficiary to effective double Federal taxation, once at the time of the deposit, once at the time of withdrawal.

• With a Traditional IRA, one always has an option to convert to a Roth IRA; whereas a Roth IRA cannot be converted back into a Traditional IRA. One can choose an optimal (lowest tax rate) time to convert over one's life. Because you have a right, but not an obligation, to convert, this is like an option in finance. Like with options in finance, this flexibility, which allows one to hedge future uncertainty, adds some additional value to the Traditional IRA.