Congress has made severalchanges in tax laws that appearto favor personal investing overtraditional retirement plan investing.Investing in tax-deductible retirementaccounts still allows physician-investorsto accumulate the most wealth on botha before- and after-tax basis.
With Roth IRAs, you do not receive anincome tax deduction for your contributions,but your investment dollars accumulatetax-deferred and withdrawalsduring retirement are tax-free. Unliketraditional retirement funds, you arenever required to take required minimumdistributions.
Physician-investors are often confusedabout the circumstances that makeinvesting in a Roth IRA advisable. As withmost investing, your particular circumstancesmay influence your best choice.The following are some general guidelinesto aid in your decision:
• Roth vs traditional IRA. Manyinvestors conclude that since distributionsfrom a Roth IRA are tax-free, it is abetter investment than a traditionaltax-deductible IRA. My research suggeststhat this is generally not the case.
Investing in a traditional IRA providesa tax deduction at your highest marginaltax rate, while taking distributions duringretirement at your lower effectivetax rate. With a Roth, you must pay yourtaxes now to reap the rewards of tax-freewithdrawals years later. As a consequence,the tax-deductible IRA is generallya better choice.
• Roth vs nondeductible IRA. I knowit seems crazy that someone might makethe mistake of investing in a nondeductibleIRA instead of a Roth, but itdoes happen. The main reason is thatthey started an automatic investmentprogram into a nondeductible IRA beforeCongress introduced the Roth IRAand they simple never changed theirplan. You should always favor a Roth IRAover a nondeductible IRA.
• Roth vs personal investing. Thecorrect choice should be obvious, butfor retirement investing, a Roth IRA willproduce more wealth than a personalinvestment program with the same contributions.While both require after-taxcontributions, no taxes are ever due onRoth profits—assuming there are norule violations.
• Traditional IRA conversion to Roth.Perhaps the greatest controversy surroundsthe advisability of converting traditionalIRA funds to a Roth IRA. The vastmajority of cases would suggest thatconverting a traditional IRA to a RothIRA is not a wise decision. The reason isthat if you convert during your workingyears, you will pay income taxes on theconverted funds at your highest marginaltax rate vs not converting and payingtaxes on your traditional IRA withdrawalsduring retirement at your lowereffective tax rate. In other words, youare choosing to pay a higher tax sooneron the assumption that receiving tax-freedistributions later makes the dealworthwhile. Under most circumstances,this will not be the case, but here theanswer is not as clear-cut as in our otherexamples, so you should meet with yourfinancial advisor if you are contemplatinga Roth conversion.
Stewart H. Welch III, CFP®, AEP,
is the founder of The Welch
Group, LLC, which specializes in
providing fee-only wealth management
services to affluent retirees
and health care professionals
throughout the United States. He is the
coauthor of J.K. Lasser's New Rules for Estate
and Tax Planning (John Wiley & Sons, Inc;
2001). He welcomes questions or comments at
800-709-7100 or visit www.welchgroup.com.
This article was reprinted with permission from
the Birmingham Post Herald.