That is a personal decision, depending mostly on how much you need the tax write-off now. But consider a person in the 25% tax bracket who starts an IRA at age 40 and contributes $3,000 a year until age 70. Assuming an average 8% annual return, the IRA will grow to over $300,000. Over the years, you will pay about $23,000 in taxes on the income you put in the Roth. If you choose a traditional IRA, you can expect to pay about $89,000 in taxes on your withdrawals at retirement.
I have created a Microsoft Excel spreadsheet that allows me to put in the specific facts for you such as tax bracket, annual contributions, years remaining to retirement, and estimated annual rate of return. This spreadsheet will then calculate the expected taxes under both a Roth and a traditional IRA. Please call or e-mail us if you would like to schedule a time to discuss your options with us personally.
One of the reasons I recommend that you have sufficient money on reserve for emergencies is that it helps you avoid the temptation to take an early withdrawal from your traditional IRA when one of the unexpected events of life hit you. In most cases, if you are under age 59 1/2, you must pay ordinary federal and state income tax, plus a 10% additional tax, on any distribution from your traditional IRA. If you have to file a California tax return for any reason (sometimes even as a non-resident), you will probably have to pay that state a 2 ½ % additional tax on top of everything else. I have seen way too many cases where people have 20% of their distribution withheld for tax, thinking that is a lot, but at least their tax is covered. Then when the actual tax works out to be 40% or even 50% of their IRA distribution, they owe thousands more when they file their tax return, which they don’t have.
I urge you to find other ways to pay for life’s unexpected events besides taking money out of your IRA early!
I hope each of you reading this considers yourself young!
There were once two young people, trying to furnish their homes, get appliances, a living room and dinette sets, a television, a sound system, and a computer. Alas, when each of them priced these items after diligent shopping for “deals”, they discovered that the total was ten thousand dollars. They anguished with the thought that there was no way they could pay such a sum in cash, and so surely they wouldn’t be able to afford these things that they needed.
The first young person went home and found an offer from a credit card company, guaranteeing him a card with a $10,000 limit, with an initial interest rate of only 3.9% for the first six months, and then 21% as a permanent rate. Excited, he called his friend! Now for only $310 each month he could have everything he needed – right now! In 48 months he would be paid in full. $310 was a lot of money to commit to every month, but it was possible, and compared to the thought of living without these essentials, it was a wonderful opportunity!
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I hope each of you reading this considers yourself young!