Water cooler discussion here today is whether or not your contributions should be pre or post tax.

My uncle has been retired for a while and he gave me the advice to always use after tax contributions. He argues this for the following reasons:
1) he owns a chunk of farm land which pays him enough to live on rice and ketchup. It is likely that I will inherit the same property.

2) He found out the hard way that money in a pre-tax account requires withdraw at age 70-1/2, at a rate which will require that you pay income tax. If he'd gone with after tax there would be no forced withdraw and he could just fill in his expenses as he needs them.

3) The common argument that income tax is never coming down. Therefore you may as well lube up now.

For this reason I use post tax dollars.

So here's the question: Do you have to pay income tax on the amount that you earn on your principal and only get the principal back because it's your money (not that this stops confiscation now, but that's a different arguement).


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I wouldn't go post tax. As soon as they figure out that we all have our money in tax free accounts they will go to a Fair Tax and get their cut anyway.

Quote:

So here's the question: Do you have to pay income tax on the amount that you earn on your principal and only get the principal back because it's your money (not that this stops confiscation now, but that's a different arguement).

If it isn't a Roth, you do pay taxes on the interest and dividends as they occur, and capital gains when you sell.

Wrong Big Cowboy. I'm not an accountant but I know in my regular IRA I pay no taxes. I will pay taxes on withdrawals starting in 20 years. But if we have switched to a fair tax who knows. My thoughts are to always make the most advantageous decision on todays taxes, because you never know what tomorrow will bring.

There's always the hedge of splitting between pre- and post-tax options. Of course, if things go to ****, your money's gone no matter where you put it...

I agree with your uncle for many of the same reasons. I, too, think that taxes now are as low as they will ever be. Also, with Roths the income on the principal grows tax free. The other advantage to a RothIRA is the ability to later withdraw money without having to pay penalties, without having to wait until you reach retirement age.

OTOH, if you think your income will be significantly lower, placing you in a lower tax bracket, when you retire, a regular IRA is the better route. IRA earnings are not taxed until you withdraw them, as themortgagedude said. Deposits can be used to reduce your taxable earnings, which sometimes can be useful to bump you down into a lower tax bracket and lower your tax liability (more than the amount of the IRA deposit).

I'm not so convinced as others that the government will ever confiscate our retirement savings. Some mistakenly assume these are the types of accounts they have confiscated in Europe when they refer to "private pensions". They aren't. In Europe, "private pensions" are like the pensions that workers here earn at government jobs, where amounts dispersed at retirement are individualized based on amounts contributed. Europe's "public pensions" would equate to our social security system.

There is no plans to go to a Fair Tax at this time. Even if they do, who knows if retirement accounts will be included in the tax, my understanding is that only current earnings would be taxed (although I could be wrong). If those earnings included earnings on retirement accounts, then probably both Roth and regular IRA earnings would be equally affected.

In any case, if you try to plan your life on all the things that MIGHT happen you go crazy. My own experience has been that the things you worry about never come to fruition. It is the curve balls that you never saw coming that knock you on your ass!

Themortgagedude: I was assuming post tax dollars in my reply to Flaps10.

-BigCowboy

The FairTax is a tax on consumption, so how do you exclude some of your savings from that tax?

Um, you don't spend like a drunken sailor?

That's not what I was asking. The statement was:

Quote:

There is no plans to go to a Fair Tax at this time. Even if they do, who knows if retirement accounts will be included in the tax, my understanding is that only current earnings would be taxed (although I could be wrong)

My question is, since its a consumption tax, how would they know whether the money you spent came from a post-tax retirement account or not-taxed current income?

Silly question. The real answer is to get a government job and wait for that juicy retirement.

Seriously you need to think about what you believe the future holds. You may want to get all you can now out of your paycheck, because who knows if the government will exist in the same form today as when you retire. However if you think the status quo will continue past your retirement age than a tax deductible IRA or 401K may be a good option for you.

As far as I'm concerned, when I withdraw that 401k money it will be so little per year it'll be in a very low tax bracket.

There are tradeable discretionary accounts, which are after tax, and tradeable IRA/Roth which can be funded en masse pre-tax or in bits post-tax, is my experience.

For example, if you had a 30k retirement account at work, and left that job, you can then move that money to a tradeable IRA. At that point, you can make 100's of trades per year and the non-govt related funds (DBA, UUP, etc), don't require any documentation of trades. The money that you make will ultimately be taxed when you cash out, but that could be decades later.

Alternatively, you could open a tradeable IRA, but I believe that money comes post tax and there is of course a limit on how much you can contribute per year.

Good thread, please correct me if I'm wrong.

Steel

Boz,
That's part of the issue. With pre-tax dollars in your 401k your are forced to take it out in a rate suitable for the IRS to tax you, whether you need the money or not.

With post tax dollars you can leave it in there or trickle it out.