3 Reasons Not to Ditch Your IRA
November 13, 2014I read this astonishing article today titled “3 reasons to ditch your IRA.” The author makes the case against contributing to traditional IRAs but all his arguments could be used against traditional pre-tax 401(k) plans as well. Before you cancel your pre-tax retirement account contributions, let’s take a look at his arguments and why they might be problematic:
1) Taxes. He’s worried that tax rates are likely to go up in the future so you could end up paying a higher tax rate on the withdrawals than you would have paid on the contributions. Yes, this is technically possible but taxes would have to go up a lot to make up for one of the benefits of tax deferral. That is when you contribute to a deductible IRA, that money comes “off the top” so it would have been taxed at your highest marginal tax bracket. But when you withdraw that money in retirement, unless you’re one of the lucky few with a large traditional defined pension benefit, a lot of that money is likely to get taxed at lower brackets.
For example, a single person would pay 10% on their first $8,925 of income, 15% on their next income up to $36,250, and 25% on their next income up to $87,850. (It keeps going but let’s stop there for now.) For a person earning $60k and contributing $5,500 to a traditional IRA, all of that money would get taxed at 25%.
If they withdraw $60k from the IRA for income in retirement, some of that money wouldn’t even be taxed due to exemptions and deductions. After that, only the amount over $36,250 would be taxed at 25%. The rest would be taxed at 10% or 15%. For the IRA to be a bad deal, the average of all those rates he’s being taxed at would have to be 25% or more, which is highly unlikely.
There’s also another benefit of tax deferral. That is that the money you would normally pay in taxes each year is instead staying in your account and earning (hopefully). As a result, you end up with extra earnings at the end.
2) Ease of use. The author’s second argument is that required minimum distributions (RMDs) are just too complicated and can result in people either paying hefty penalties or thinking that’s the maximum they can withdraw. Here’s where a little education can go a long way. The institution holding your account will calculate the RMD for you so all you need to do is withdraw at least that amount before the end of the year. How complicated is that really?
Compare that with the tax implications of managing a regular account. You have to track your cost basis and calculate the capital gain or loss (short term or long term) and then net them out to determine your tax liability. Then you have the foreign tax credit, wash sale rules, and the carry forward of losses against ordinary income tax. That RMD doesn’t sound so bad now does it?
3) Estate planning. His final point is that IRAs also complicate estate planning. Actually, I would say the opposite. The nice thing about IRAs from an estate planning perspective is that you can designate beneficiaries and have your IRA pass to them without going through the time and cost of probate. If you want to avoid probate with a regular individual account, you’d have to request and complete a separate transfer-on-death form to designate beneficiaries (if your state allows it) or hire an attorney to draft a trust.
Don’t get me wrong. There are good reasons not to contribute to a traditional IRA. These just aren’t them.