A reader has just written in urging me to take another look at Roth IRAs. This follows my previous column, in which I said I was wary of them, partly because I figured I’ll be paying a lower tax rate in retirement than I am while I’m working.

“The tax rate is not the issue; it’s the amount of tax you will be paying,” he reminds me. And he argues that many people will end up paying less in total tax over their lifetime if they use an after-tax Roth IRA instead of a pretax traditional one.

I’m coming back to this topic because he raises a very good issue — and because Congress is considering slamming the Roth IRA door closed for good for upper-middle-class earners. So we might only have a few months to make this big financial decision, which could have an outsized effect on how much money we have in retirement.

Obvious first point: The math is complicated, and if in doubt you should talk to a financial adviser.

But in very broad-brush terms, there are two simple principles that the reader raises.

First, if you are superbullish on the investment outlook, and you think stocks are going to boom for the rest of your working life, then the math says you should lean toward the Roth. Better to pay a small amount of tax now than the vast sums you’ll owe on your millions down the line.

Second, if you expect to be paying a similar marginal tax rate in retirement to the one you are paying now, you should also lean toward the Roth.

On the other hand, if you don’t share these two assumptions, it isn’t so clear.

The reader illustrated his point by imagining someone in the 24% federal tax bracket while working and the 22% tax bracket in retirement, and who earns 8% a year on average on his or her investments. By the time that person reaches retirement age, my reader points out, the tax owed on a traditional IRA will vastly exceed the amount they’d have paid over the years if they’d contributed to a Roth instead. The tax bill could be many times higher. 

He’s right. But I’m nervous about these assumptions.

Do I think I’m going to earn 8% a year over the long term on my investments? As we are using real, constant dollars in these assumptions, that means: Do I think I’m going to earn 8% a year in “real,” or after-inflation, terms?

See: Should I roll my Roth 401(k) into a Roth IRA?

My gloomy take: Dream on.

The long-term real average on U.S. stocks has been around 6%, and even to get to that number we have to include the skyrocketing returns of the last 40 years. My problem with including all the returns from 1980 is not that they haven’t occurred, but whether they’re going to occur again over the next 40. People on Wall Street use many Greek letters, extravagant calculations and incomprehensible economese to explain why the more expensive stocks get, the better their future returns, but they don’t make any sense to me. Isn’t this double counting? Stocks in relation to underlying fundamentals are much, much more expensive than they were 40 years ago. Doesn’t that mean their future long-term returns are likely to be lower?

I’m also wary of thinking I’m going to be paying the same income-tax rate in retirement as I do while I’m working. I’m expecting to be earning less from my investments than I do as a worker bee. I may also move to a lower-tax state. Many upper-middle-class earners are currently paying state taxes as well as federal, and some, such as those in New York City, are paying a city tax as well.

Seems to me, I’d only have to worry about that as a major issue if my retirement plans are loaded by the time I retire — and in that case I’m not so worried about the taxes. My real concern isn’t with how much I pay in tax, but how much I’m going to have left on which to retire. My worry is about paying extra taxes now, at high marginal rates, and then having to tighten my belt when I’m in my 80s (if I get there).

One of the things I like about traditional IRAs is that they will only hit me with a big tax bill in retirement if I’m doing pretty well.

Then there is the final worry, as I mentioned in my previous column, that if I volunteer to pay additional taxes now to convert a traditional IRA into a Roth, what’s to stop a future Congress from taxing that money again — couched, naturally, not as double taxation but as a “crackdown” on “loopholes.”

Maybe I’m being too cynical.

One thing that Roth IRAs have going for them is that they effectively involve making a greater annual contribution to your IRA. With a traditional IRA you can contribute up to $6,000, or $7,000 if you’ve over 49. But some of that money has to be set aside effectively to pay for the taxes you’ll owe when you withdraw the money.

With a Roth, you have already paid those future taxes, so you are in effect contributing more. Someone in a 24% federal tax bracket who contributes $6,000 to a Roth IRA (using a backdoor Roth or conversion) is actually contributing about $8,000 gross, because they’re first paying about $2,000 tax on the money.

So maybe I should bite the bullet. And put some trust in the stock market and Congress. (Cue laughter.)

Of course it would be really, really helpful if the powers that be could arrange for another financial panic between now and Christmas, so we could all convert our traditional IRAs to Roths at depressed values and save on the taxes. Looking at the MarketWatch home page I see the Dow Jones Industrial Average
DJIA,
+1.43%

down about 1,500 points since the middle of August and the S&P 500
SPY,
+1.19%

off 5% in a month. So maybe this discounting is in the works. How thoughtful!

Read on: How to decide whether to invest in a 401(k), a Roth 401(k) or a Roth IRA

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