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The Taxpayers Relief Act of
1997 creates the Roth IRA retirement savings account.
ORP models the Roth IRA in two ways:
- Before retirement you can specify that contributions can be made
to a Roth IRA.
- After retirement ORP may, under circumstances, indicate that
partial rollovers from your IRA to a Roth IRA will be financially
benifical.
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Very briefly,
a Roth IRA is a savings account that is funded with after-tax
dollars but returns are accumulate and are withdrawn without
paying any Federal Income Tax. There are restrictions:
- Contributions are limited
and are available only to lower income wage earners.
The amount of the limitions are in
IRS Publication 590
- Distributions are penalized
if taken before age 59 ½.
- Distributions cannot begin
until five years after the first contribution..
On the other hand:
- After 2010 an existing IRA can be rolled
over into a Roth IRA without restrictions.
- There is no minimum withdrawal
level that begins at the age of 70 or any other time, as there
is with a conventional Tax-deferred Account.
For more information about
the Roth IRA see:
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Looking at the Roth
IRA with ORP |
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The Roth IRA
is a different ORP model component than the regular Tax-deferred
Account. Additional columns have been added to the current ORP
reports to report on the Roth IRA, and an additional Roth IRA
account report has been added.
Three new parameters have
been added to ORP to include the Roth IRA into the model. They
are:
- Planned annual contributions
to the Roth IRA before retirement:
The contribution restrictions noted above are enforced by ORP
except that it is up to user to determine if her Adjusted Gross
Income is below the specified limit. Note that these are after-tax
dollars so if it is planned to replace 401K contributions with
Roth IRA contributions be sure to allow for paying income taxes
while figuring the contribution.
- Initial Roth IRA account
balance: Since the Roth
IRA is brand new, the initial account balance is really a roll
over from an existing IRA. Remember to allow for taxes while
computing the roll over balance. (Taxes may be paid across four
years, which eases the pain a bit.)
Leaving both of the parameters
blank in the ORP parameter screen will omit the Roth IRA component
from the model. |
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There are situations
when contributing to a Roth IRA is to desirable; other situations
when such contributions are sub optimal. This
can be seen analytically:
V = (1-t)*b*(1+r**y) is the
value of a regular IRA at year y, earning at rate r, starting
with before-tax balance b and paying tax rate t at the time of
distribution.
R = (1-T)*b*(1+r**y) is the
value of a Roth IRA at year y, earning at rate r, starting with
before-tax balance b and paying tax rate T at the time of the
contribution.
Clearly, if t = T then V =
R and whole thing is a wash.
However if t < T which will
occur, for example, with a medical student working part time
at the fry machine in McDonalds who will have a current marginal
income tax rate substantially below her retirment income tax rate.
Contributing to a Roth IRA under these circumstances is a
great deal.
On the other hand if t > T,
i.e. current income is in a higher marginal personal income
tax bracket then that anticipated for retirement then a
regular IRA is to be preferred.
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The three
additional parameters described above, when used in conjunction
with the other ORP parameters can be used to answer questions
about the Roth IRA.
Be sure to include the tax
consequences when switching from a regular IRA to a Roth IRA.
Taxes must be paid from a rolled over balance before becoming
a Roth IRA beginning balance. Taxes must be paid before dropping
a regular IRA contribution in favor of a Roth IRA contribution.
Tax considerations can be
omitted when supplementing retirement savings with additional
contributions to a Roth IRA.
Use the retirement tax rate
parameter to account for reduced taxable income during retirement
caused by taking money out a Roth IRA instead of a regular IRA. |
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In 1996, Congress
changed the tax law to suspend excess withdrawal penalties on
Tax-Deferred Accounts. The reason for this was, as explained
at the time, to encourage taxpayers to take large Tax-deferred
Account distributions immediately, and pay personal income tax
on them. This would increase current government revenues, at
the expense of down stream revenues. ORP results indicated that
this was not a good idea for most retirees.
Now, in the form of the Roth
IRA, Congress is at it again. Rollovers of regular IRAs into
Roth IRAs will increase immediate government revenues at the
expense of down stream revenues. Several ORP models show that
the main difference between rolling over and not rolling over
comes is higher taxes paid down stream in the non-rolled over
case. Money available for spending remains the same.
Remember that this is all
part of the congressional balanced budget package.
Please share your results
and observations with us so that we might enhance this section
of the web site.
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© 1998-2009, Sundown Software Systems, Inc.
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