Defending Traditional IRAs

BY JIM GERMER
Special to the Herald

Practically every time I turn on CNBC, I hear best-selling author Suze Orman overselling the benefits of Roth IRAs. "Unlike traditional IRAs, contributions to Roth IRAs aren't tax deducible," she says. "Qualified distributions from a Roth IRA are not taxable, either."

Fed Chairman Janet Yellen said recently that the wealthiest 5 percent of Americans own two-thirds of financial assets, such as stocks, bonds, and mutual funds. And using a threshold of $1.9 million in net worth, or $209,000 in income, the Washington-based Federal Reserve and the Tax Policy Center recently calculated the top 5 percenters.

I am sure, as most of my fellow CPAs would agree, that the typical Sarasota or Bradenton retiree isn't in the top 5 percent. Most local retirees, in my opinion, are lucky to have a small pension, social security benefits and $200,000 in an IRA.

Yet brokerage firms routinely bombard us with Roth IRA advertisements on TV, Internet, and newspapers. Usually ads go something like this: Save a fortune in future taxes with a Roth IRA. If a Roth IRA, for example, grows to $1 million, after contributing $5,500 for 20 years, you likely pay zero income tax. No doubt the possibility of saving more than $200,000 in income tax is practically irresistible for someone in a high tax bracket at retirement.

Sadly there's a disconnect, I believe, in the financial press -- the Ormans of the world -- and those working paycheck to paycheck. So here's some financial advice for people who aren't rich, and probably won't ever be rich.

I find most working people, the bottom 95 percent of us, usually don't benefit with Roth IRAs. Traditional IRAS, however, usually offer an immediate tax break -- you likely get a bigger tax refund and cash-in-hand now.

For example, a husband and wife in a 20 percent tax bracket, who each contribute $5,500 to a tradition IRA, might save more than $2,000 dollars in income taxes. There is also an additional retirement savings credit for IRA and 401K contributions ranging from $1,000 to $2,000 available for low- and moderate-income households.

I think you can see where I'm going with this: The odds are greater at retirement that you'll be living in a doublewide in Colony Cove than in a Longboat Key penthouse

Our government strives for fairness for certain classes under our regressive tax system. If you're a retired physician, with $3 million in investable assets and a paid-off house, this isn't you. Instead our tax code favors retirees living on a fixed incomes and families earning less than $50,000 a year.

A married couple, in their late 60s for example, can gross about $54,000 including $35,000 in Social Security, $10,000 from a traditional IRA, and a $9,000 pension -- and "still" pay no tax.

Get it? The couple get an extra $2,000 tax refund while working, and when they take a $10,000 distribution from their traditional IRAs at retirement, they will pay no income taxes. How cool is that?

Sadly many people invest in Roth IRAs when they have no business investing in Roth IRAs. In the example above, a couple using Roth IRAs would have forfeited the $2,000 tax savings that the traditional IRA offered. Roth and traditional IRA distributions, in this example, "wouldn't" have triggered any income tax.

If you're not a 5 percenter, take comfort. You can live pretty well on $54,000 a year, especially if you pay no taxes on distributions from a now hip traditional IRA.

Jim Germer is a Bradenton CPA and financial adviser at Cetera Financial Specialists, LLC, member FINRA/SIPC.