Is it better to get a tax benefit now and pay taxes later on retirement income, or vice-versa? Bloomberg econobogger Megan McArdle ponders the question in To Roth, or Not to Roth:
In theory, the calculation is easy: Figure out whether your tax rate is likely to be higher now or in the future. If you’re young, the answer is likely to be “future”; if you’re in your peak earnings years, you’re probably looking at a lower tax rate when you’re retired.
But while the theory is simple, in practice, things are considerably more complicated. Personal finance is less about math than psychology . . . and tax policy, in this case. What will the tax rate on your income be when you retire — higher or lower than your current tax rate?
“Roth” IRAs and 401(k)s offer no current tax reduction, but if the account is left untapped long enough, there is never an income tax on the earnings. It’s not always a tough choice. Many young people face a marginal income tax rate of zero. To the extent a low-earning young taxpayer benefits from a 401(k) plan or saves in an IRA, you might as well go with a Roth version, as there is little or no current benefit anyway.
As you climb the income ladder, it quickly becomes a more difficult decision. When my company first had a Roth option, I opted in for a year. Then it occurred to me that I was making a bet on much higher tax rates in the future at much lower income levels. That seemed like a losing bet (but see this) and I switched back to the traditional 401(k) with current tax savings.
Megan also notes a real, if hard to quantify, problem with betting on future benefits (my emphasis):
We’re running some substantial deficits, and we’ve made some big promises to retirees. Those obligations will have to be paid for somehow, and by “somehow,” I mean “With higher taxes on someone.” What are the chances that you’ll be that someone? Pretty high, if you save a lot for retirement.
That makes a Roth sound like a pretty good bet. But unfortunately, the same logic that suggests higher income taxes in the future also suggests that a hungry-eyed Congress might settle on all those fat tax-free retirement accounts as a way to balance the books. What Congress giveth, Congress can taketh away. Can you really count on that income being tax-free when it’s finally time to collect it?
If you think no politician would be so brazen, just remember: “If you like your doctor, you will be able to keep your doctor, period. If you like your health care plan, you’ll be able to keep your health care plan, period. No one will take it away, no matter what.”
Good thing the ACA solved the problem of the uninsured. Report: 230,000 Iowans still lack health care coverage (Des Moines Register). Good thing we destroyed the health insurance industry and imposed a whole series of punitive and complicated taxes.
Russ Fox, Deadlines for Us, But Not for Them (Part 2), “Later this week it will be seven months since my reply was received. Another nine-week hold has been put on collection activities as the IRS admits that there is correspondence waiting to be reviewed. If we go nine more weeks it will be over nine months since I responded.”
Another reason for a sauce-for-the-gander rule, applying the same rules to the IRS that they apply to us.
Robert D. Flach has a similar state-level example from New Jersey in THE DFBs!
We are told (highlight is mine) -“New Jersey wrongly notified about 2,000 taxpayers that they underpaid their 2013 taxes, but the state won’t notify them about the error unless the taxpayer asks, possibly causing taxpayers to send the state money that wasn’t owed.”
Tar and feathers.
Peter Reilly, Real Estate Dealer Or Investor – Can’t Switch At Drop Of Hat. ” One of the more challenging questions in income taxation of real estate transactions is whether a taxpayer is a dealer or an investor.” Investors get capital gains, dealers don’t.
TaxGrrrl, Tax Extenders Bill Stalled In Senate. The latest move in the dance to the inevitable last-minute re-extension of the perpetually-expiring tax breaks.
Jack Townsend, Booker Variances are More Common in Tax Crimes. Why? And Do They Disproportionately Benefit the Rich? He discusses variations from federal sentencing guidelines, including the shockingly-light sentence given Beanie Babies tycoon Ty Warner.
TaxProf, The IRS Scandal, Day 375
William McBride, Top 10 things to Know about Investment and Tax Policy. (Tax Policy Blog).
Number 2: “Investment in the U.S. has yet to fully recover from the recession and remains near a record low.”
Number 10: “Of the ways to change tax policy to improve investment, expensing generally provides the greatest “bang-for-the-buck” because it applies strictly to new investment.”
Renu Zaretsky, Tax Mistakes, Collections, and Breaks. Today’s TaxVox headline roundup covers a proposal to revive the use of private collectors in federal tax collection and “Affordable Care Act subsidy mistakes now could mean huge tax confusion later.”
Annette Nellen asks What’s missing from Camp’s tax reform proposal? She has suggestions.
The new Cavalcade of Risk is up at Waterwayfinancialgroup.com. The venerable roundup of insurance and risk-management posts includes Hank Stern on the possible perils of ride share. There is risk in letting other people use your car, as anyone who has seen Animal House knows, and those risks may not be covered under your car policy.
News from the Profession. Another EY Associate Taking a Stab at Reality TV (Going Concern)
Honor among fraudsters. Owners of a nostalgia-themed restaurant chain in Pennsylvania and New Jersey went up the river on tax charges last year. Now comes word that the inside accountant who (allegedly) helped them cheat on taxes also (allegedly) helped himself. From Philly.com:
An indictment unsealed today charges 58-year-old William J. Frio, of Springfield Township, with conspiracy, filing false returns, loan fraud, and aggravated structuring of financial transactions.
Prosecutors say Frio, who has been providing accounting services to Nifty Fifty’s since 1986, conspired with the popular chain’s owners in a scheme that used skimmed cash to help themselves and associates avoid paying taxes.
He also allegedly used his role as Nifty Fifty’s accountant to embezzle hundreds of thousands of dollars from the organization.
Aside from the obvious risk of going to jail, there are other complications that arise when businesses cheat on their taxes. Unless your business is tiny, you need some help from your accounting staff. When your bookkeeper is willing to defraud the government, don’t be shocked if he isn’t perfectly honest with you.
Tags: ACA, Annette Nellen, Going Concern, Jack Townsend, megan mcardle, News from the Profession, Obamacare, Peter Reilly, Renu Zaretsky, Roth 401(k), Roth IRA, Russ Fox, sauce for the gander, tax crime, TaxGrrrl, TaxProf, William McBride