When I talked recently with Ted Benna, the man often credited with inventing the 401(k) plan, the subject turned to the vexed issue of Roth and “traditional” IRAs.
With Roths you get a tax break only when you withdraw the money. With traditional IRAs you get the break up-front, in the year you contribute. Few topics seem to be as controversial among the saving public as the debate over which is better.
And at the risk of inciting another flame war, Benna thinks Roths are nowhere near as good as they’re made out to be. He believes traditional IRAs are likely to prove much better for most people.
That’s partly because most of us are likely to face lower tax rates in retirement than we do while we’re working, so a tax break then will be worth less than one today.
That’s one reason why Benna is skeptical of the widely used argument that you should get a Roth IRA because income tax rates are likely to be much higher in the future than they are now. People were saying that back in the late 1990s, when the Roth was first created, he points out. Instead income tax rates are way lower.
But he also fears that Roth investors may end up getting hosed by the government. He’s worried that politicians may end up taxing Roth withdrawals, at least for some, in the future. “I don’t trust the politicians,” he says.
If that happens, anyone with a Roth will effectively be taxed twice: Once when they put money in, and then when they take it out.
If this sounds like a far-fetched, paranoid conspiracy theory, Benna has a warning for you: This is exactly what politicians did to Social Security, he says.
Social Security benefits used to be completely tax free. Then in 1984 the federal government, under Ronald Reagan, changed the rules. Now you can be taxed on up to 85% of your Social Security income.
This, Benna points out, is effectively double taxation. That’s because both your federal income tax and Social Security taxes count as part of your gross income for federal income tax purposes. So, as Benna puts it, you pay federal income tax on your Social Security contributions, and then you can be taxed on your benefits.
So don’t think the folks in Washington will balk at the idea of taxing you twice on other retirement savings, like your Roth, he says.
Benna is now in business advising small companies on retirement plans, which, as I pointed out recently, typically means warning them away from the big company 401(k)s he once pioneered. He also has a new book out, “401(k)s & IRAs for Dummies,” co-written with Brenda Newmann.