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Roth versus Traditional IRA: The Age Old Question

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A guide to help readers determine which is better for their financial situation: the Roth or Traditional IRA.

There is no right answer. Real helpful, huh? To elaborate, the answer depends on your unique financial circumstances and goals. To determine which retirement plan is best, you will want to consider a few important questions. Where are you now? Where will you be when you retire? How will you get there?

Both forms of the IRA are great ways to save for retirement, although each offers different advantages.

Traditional IRA:

  • Tax deductible contributions (depending on income level)
  • Withdraws begin at age 59 1/2 and are mandatory by 70 1/2
  • Taxes are paid on earnings when withdrawn from the IRA
  • Funds can be used to purchase a variety of investments (stocks, bonds, certificates of deposits, etc.)
  • Available to everyone; no income restrictions
  • All funds withdrawn (including principal contributions) before 59 1/2 are subject to a 10% penalty (subject to exception).

Roth IRA:

  • Contributions are not tax deductible
  • No Mandatory Distribution Age
  • All earnings and principal are 100% tax free if rules and regulations are followed
  • Funds can be used to purchase a variety of investments (stocks, bonds, certificates of deposits, etc.)
  • Available only to single-filers making up to $132,000 or married couples making a combined maximum of $194,000 annually.
  • Principal contributions can be withdrawn any time without penalty (subject to some minimal conditions).

Tax Deferred vs. Tax Free

The biggest difference between the Traditional and Roth IRA is the way Uncle Sam treats the taxes. If you earn $50,000 a year and put $2,000 in a traditional IRA, you will be able to deduct the $2,000 from your taxes (meaning you will only have to pay tax on $48,000 in income to the IRS). At 59 1/2, you may begin withdrawing funds but will be forced to pay taxes on all of the capital gains, interest, dividends, etc., that were earned over the past years. The Traditional IRA is therefore tax deferred.

On the other hand, if you put the same $2,000 in a Roth IRA, you would not receive the income tax deduction. If you needed the money in the account, you could withdraw the principal at any time (although you will pay penalties if you withdraw any of the earnings your money has made). When you reached retirement age, you would be able to withdraw all of the money 100% tax free. The Roth IRA is going to make more sense in most situations. Unfortunately, not everyone qualifies for a Roth. A person filing their taxes as single can not make over $132,000. Married couples are better off, with a maximum income of $194,000 yearly.


Peter Atwater Suggests Eliminating FDIC as Part of Banking Reform

Peter Atwater, one of the individuals responsible for building JP Morgan's securitization business during the late 1980s and early 1990s believes that doing away with the FDIC will help promote bank stability and soundness in the future. It's one of five recommendations he gives as part of banking reform. In an article posted on Yahoo Business entitled Five Suggestions for Banking Reform, he writes:

"Second, and at the risk of being bold, I believe the time has come to eliminate FDIC insurance. When the FDIC was created in the 1930s, it was intended to be a temporary solution. Today, it puts the US taxpayer on the hook for more than $7 trillion in bank liabilities. But as a consequence, depositor due diligence is non-existent. And putting Wall Street aside, this crisis has shown, even with specific oversight, hundreds of now-failed banks took excessive risk in their traditional banking businesses and their insured depositors neither cared nor were adversely impacted. Their risk was borne by the government, while they earned returns far in excess of comparable US Treasuries. If we're truly going to eliminate "moral hazard"/"too big to fail" we must eliminate deposit insurance in the process."

It's an interesting and bold idea, but one that ignores the reality of how FDIC insurance works and how it can be made better. First, banks fund and pay for FDIC insurance. The taxpayer does not. Yes, the fund is ultimately backed by the US Treasury but it has as of yet had to pay anything to depositors, even in the most recent financial crisis. Instead, the FDIC placed an extra levy on the banks to help recapitalize the fund. That seems entirely appropriate.

Second, without FDIC insurance, bank runs would become much more common and debilitating. Any news of a bank problem would be met with a rush of depositors trying to get their money out. A bank could collapse based solely on rumor. The orderly unwinding of a financial institution would be impossible.

Third, doing away with FDIC insurance assumes that consumers have access to the proper information to make decisions about bank viability, security, safety, and soundness. It is unclear if that information exists or that consumers would be able to process it. For example, even though Indymac was widely expected to fail for several weeks, a significant percentage of the deposit base had money there in excess of FDIC insurance levels. What is more likely to happen, is that after a few banks go under and consumers lose money, they'll begin to pull money out of the banking system and stuffing it under their mattress. That removes money from the banking system that can be used for other productive purposes.

A far more effective remedy would be to increase the percent that banks have to pay into the fund based on their leverage and risk ratios as well as their projected losses. Banks go through cycles of boom and bust and smoothing that cycle for consumers is the best way to help consumers, not removing any kind of bank responsbility for keeping their depositors whole. As we've seen, banks are incapable of self-regulating and could care less about losing investor, depositor, and government money.

The article also is sanguine about the Volcker rule, which recommends re-siloing banks based on whether they use consumer deposits or not.

"First, as much as I admire Mr. Volcker and the noble intentions of the "Volcker Rule," I'm afraid that attempting to re-silo the financial services industry is akin to trying to unscramble an egg. In fact, with all due respect to the myriad of regulators currently in place, I think our existing silo'ed regulation contributed mightily to our crisis."

In a sense, the end of Glass-Steagall and the repeal of the FDIC would remove two big pillars of bank regulation put in place after the Great Depression. I find it ironic that the banking system was relatively stable from the late 1930s through 2007. Is it coincidence that the banking system crashed so shortly after Glass-Steagall was repealed? What would happen if Great Depression remedies were further removed and FDIC insurance abolished?

Those that fail to learn from history are doomed to repeat it. What we need now are clear remedies to a broken banking system, not a return to a past that we know doesn't work.


Paid Your Taxes Yet? Your Bank Probably Hasn't.

Despite the fact that most of us have been either writing checks to Uncle all year or are preparing to write one big one now, the banks we do business with are less likely than ever to pay taxes for 2009.

Chances are you're goggling at that headline right now--not pay taxes?? How is THAT possible?

Oh, it's quite possible. And when you look at why, it actually makes sense.

See, banks have been having a pretty bad year. Oh, who am I kidding? Most every business everywhere has been having a bad year. But in business, you pay taxes based on your adjusted gross income. Adjusted, of course, against allowable deductions. Small business folk think of this in terms of capital investment or mileage or any of a hundred other things, but for big businesses (like banks) a seriously large allowable deduction comes in the form of BUSINESS LOSSES.

If you're just starting out in business, you may already be familiar with the idea that the government lets you declare a business loss on your taxes for up to seven years consecutively before no longer allowing it as a tax deduction. Thus, many people with more "hobby-based" businesses will run them at a loss to give them a more favorable tax picture (special note--if you're thinking about trying this yourself, don't, at least not without the counsel of a CPA). And this year, most every business (especially a whole lot of banks) operated at a loss, or bought money-losing divisions, thus allowing them to declare a paltry income or even a full-on loss.

Thus, some of the biggest companies out there, including some who got themselves a whole load of taxpayer money, will not actually be taxpayers themselves for FY 2009.

Kind of makes you think twice about storing YOUR savings in mattresses, huh?