Q: Are Traditional IRAs the Way to go in Saving for Retirement?

A: The traditional IRA can be either boon or bane, depending on your particular circumstances and stage of life. IRA rules are much more complicated than most people realize since there are about a million pages of rules regarding investment in them and then later withdrawal. Okay, not a million, but are you any more likely to read a couple hundred and understand those “few” than the million? Even a C.P.A. who understands more than the basics is rare.

All that said, the Forrest Gump inspired question about the traditional IRA, “Is that a good thing or a bad thing?” is best answered by, “It’s a good thing”.

Most people tend to believe the biggest advantage of the traditional IRA is the tax-deduction. But in the grand scheme of things, the tax-deduction might be compared to getting married. Romance and oo-la-la may be why couples couple, but what ultimately matters more is that children are born and thus the human race continues racing. Likewise, the ultimate result of investment in IRA’s is more than the sexy tax-deduction, it is (1) the segregation of funds into a category exclusively for retirement, and also that (2) these funds grow without taxes.

Both of these less than exciting issues are mightily important. First, people tend not to save for retirement. They tend not to look beyond next week. Tax-deductible IRA’s motivate them to do something about a problem they too often otherwise ignore.

Second, the average Joe or Josephine fails to understand the double magic of compound interest and tax deferral. Even a little bit of interest when given many years to compound can multiply an original investment beyond what most people imagine possible. Allow it to do that without Uncle Sam taking his annual slice, through the miracle of tax-deferral, and you have accomplished without breaking a sweat a powerful blow for eventual financial independence.

So far, we have the gist of the “boon” aspect of IRA’s, so let’s briefly address the “bane”. Sometimes the long-term segregation of funds for retirement is a grave inconvenience. If you must remove the funds prior to retirement, you are likely not only to pay tax but a ten per cent tax penalty. For most people, in most circumstances, this risk is worth taking, but it is a risk the investor needs to understand.

Also regarding the “bane” aspect, there may come a time when you have such a large portion of your wealth in an IRA that the combined income and estate taxes upon your death are confiscatory. Under present law, this should be an issue for only those worth millions. But laws change. Plus, with inflation there will likely come a day when millions are necessary in a retirement plan to provide the income needed for your financial comfort.

Final answer: Traditional IRA’s are a good thing—mostly.

Ernie McDaniel is a Chartered Financial Consultant and President of McDaniel Financial. He can be reached at 318-798-9022 or via email.