Email question: What are your thoughts on a traditional IRA vs. a Roth IRA?

Pete:

I follow your blog and appreciate what you do to help people get on financial track. I’m curious what your thoughts are on converting a traditional ira to roth.  We have a significant sum we would like to convert but the tax hit stinks.  We are 40 so it makes sense at this point but would love to get your thoughts on ways to limit tax impact.

Different note, you referenced in an earlier blog that you spent $60 on groceries a week.  Really?  I thought I was frugal but that beats my budget of $100 (2 adults/2 kids).  Where do you shop in Indy to pull that off?  What about wine–does that go in a different budget area?  Also, paper products, laundry soap, etc. 

What is your eating out budget?  I haven’t seen any blog on that topic…

Thanks for your insight. -Michelle

Thanks for the questions Michelle. As for your first question, I’ll answer it on one condition, we agree this is my unofficial tax advice. This is definitely a question for your accountant, but here are my two cents. A traditional IRA is a type of qualified account, meaning the money inside the account has never been taxed. The money grows tax deferred, you will only pay taxes when you remove the money from the account. Because of this your question is more philosophical than technical. Why? Because it has to do with opinions on tax rates. Your question about converting to a Roth implies you believe tax rates consistently go up, so taking the tax hit now will be less painful than in 25 years. I’m not so sure. This is where the question gets philosophical. Tax rates vary over time. They go up, they go down. I’m not saying they won’t be up when it’s time for you to withdraw from a traditional IRA or 401(k) but there are other things to consider. For example, in retirement you’ll most likely be withdrawing a lower income than you currently make, meaning you’ll be in a lower tax bracket, thus your withdrawals will be taxed at a lower rate. Like I said, I’m hedging because I don’t know the particulars of your situation. I highly recommend discussing your situation with an accountant.

The blog post you are referencing where my grocery budget was $60 a week was back when my wife and I only had our daughter. Today we also have a Tedd, who at 2, eats more than me. Our grocery budget is now in the $100 a week range (we shop at Trader Joe’s mainly). This does not include paper products, detergent, etc. Those things add another $100-150 a month.

As for dining out, we do budget for that separately. I’ll do another blog post on dining out specifically another time, but for now, I’d say you can either include it in your food budget or rope in your entertainment budget. It really just depends on your lifestyle.

Michelle, I also answered your question this week on The Pete the Planner Radio Show. Listen here for my full answer:

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