The war in Afghanistan will wind down for NATO troops. That's clear from today's news. Leon Panetta will take over the Defense Department from Robert Gates. Gen. David Petraeus will get Panetta's job running the CIA. Adm. Mike Mullen, Chairman of the Joint Chiefs of Staff, isn't eligible to be renominated. The chain of command that presided over last year's surge in Afghanistan is being dismantled. That's one of the easiest ways in Washington to change policy. Top officials don't have to change their minds; they just change jobs.
By drawing down forces in Afghanistan, President Obama would keep a campaign promise, and satisfy the wishes of the majority of Americans who recent polls indicate want the U.S. out of the war. Besides, there's more than one way to skin this cat. Today's Wall Street Journal reports on P. 1 that the Pakistani government has urged the Afghan government to join in an alliance with Pakistan and China. The Pakistanis, who may be worse enemies of America than the Afghans, are now more aggressively undermining America than ever before. America's relations with India are improving, and we may be better off easing out of Afghanistan and Pakistan, and exercising influence in South Asia by strengthening ties with New Dehli.
Meanwhile, back at the Fed, Chairman Bernanke did a fairly decent imitation of Alan Greenspan at the Fed's first ever press conference. Bernanke said . . . well, try to figure out what he said. The reaction of most listeners was to parse, then parse some more, and then parse some more. Greenspan was famous for lengthy vocalizations that meant little except, "I'm keeping my options open." Looks like Bernanke prepared for today by watching old game films from the Greenspan era.
The Fed itself released a statement earlier today, following its April meeting, in which it said it would stay the course. So the sum total of this month's Fed meeting and today's press conference is we know pretty much what we knew before. The stock market took it all positively, assuming that the Fed will keep the monetary printing presses rolling 24/7. Maybe. But Bernanke did keep all options open. His remarks that could mean QE3 is coming could also mean that the Fed will drain liquidity, depending on circumstances.
And that's the problem with today's Fed. Even though Ben Bernanke has said he wants to provide greater transparency, the tendency of the markets to pop or swoon over a lifted eyebrow or a hint of a frown has forced him to be measured, and then cautious, and today, simply ambiguous. He ends up telling us very little, which lets the markets interpret his remarks as they wish and force the Fed to follow their lead. Today's positive market reaction highlights the financial system's dependence on subsidies from the Fed, and increases the cost to the Fed of changing its policies. A fall in the stock market is virtually guaranteed whenever the Fed changes policies, and that puts enormous political pressure on the Fed to keep printing money indefinitely. By purporting to provide transparency, but not actually doing so, the Fed is losing control over monetary policy. All this is fine if no amount of money printing leads to significant inflation. If only we lived in Wonderland, where one can believe as many as six impossible things before breakfast.
Wednesday, April 27, 2011
Monday, April 25, 2011
A Question for the Chairman: Is the Fed Doing Its Part to Reduce the Federal Deficit?
This week, Chairman Ben Bernanke of the Federal Reserve holds the first ever press conference by a Fed Chairman. The wisdom of opening himself up to volleys of dumb, loaded, and unfair questions isn't crystal clear. Since, however, he's voluntarily decided to position the seat of his pants in the middle of a firing range, here's a question that should be posed to him.
It's Econ 101 that the lower the price of something, the more of it people will consume. Isn't the Fed making it easy for the federal government to run massive deficits by keeping interest rates ultra low?
The stated purpose of low interest rates is to stimulate the economy. But they also stimulate government borrowing. Look at Japan. Its public debt is something like 200% of its GDP (America's is around 70%). But interest rates in Japan are so low that the government's annual bill for borrowing all this moola isn't terribly painful. Most Japanese government debt is held by Japanese citizens, who seem perfectly willing to refinance the government every time its debt falls due, asking for scarcely any interest income at all. From an economic standpoint, it makes sense for the Japanese government to keep borrowing. Since it can roll over maturing debt at will for ultra low rates, it never really needs to control its deficits and can keep borrowing more at minimal interest expense. The U.S. Treasury, too, can easily roll over its debt at historically low prices. So its need to reduce deficits isn't pressing.
The Fed's low interest rate policy is inflating commodities and equities, but its impact beyond that is unclear. Big banks aren't increasing the net amounts of their loan portfolios and small businesses still limp along with working capital from their owners' credit cards. Real estate remains moribund, with more of the same expected for the future. Raising interest rates will make financial markets speculators unhappy. But let's remember that central bank manipulation of asset prices doesn't produce lasting prosperity, but indeed the opposite (for further reading, see 2007-08 financial crisis).
For all the political hoopla over deficits, reality is that money talks and bullsh . . . uh, political dialogue walks. What's forced Greece, Ireland, Portugal and other Euro bloc nations to rein in their spending? Not frowning bureaucrats in Brussels, but rising interest rates demanded by their creditors. Chairman Bernanke recently scolded Congress and the administration for not doing enough to reduce the deficit. Well, remember, Mr. Chairman, money talks and bu . . . well, you know. If you want the government to reduce the deficit, make it pay for borrowing.
It's Econ 101 that the lower the price of something, the more of it people will consume. Isn't the Fed making it easy for the federal government to run massive deficits by keeping interest rates ultra low?
The stated purpose of low interest rates is to stimulate the economy. But they also stimulate government borrowing. Look at Japan. Its public debt is something like 200% of its GDP (America's is around 70%). But interest rates in Japan are so low that the government's annual bill for borrowing all this moola isn't terribly painful. Most Japanese government debt is held by Japanese citizens, who seem perfectly willing to refinance the government every time its debt falls due, asking for scarcely any interest income at all. From an economic standpoint, it makes sense for the Japanese government to keep borrowing. Since it can roll over maturing debt at will for ultra low rates, it never really needs to control its deficits and can keep borrowing more at minimal interest expense. The U.S. Treasury, too, can easily roll over its debt at historically low prices. So its need to reduce deficits isn't pressing.
The Fed's low interest rate policy is inflating commodities and equities, but its impact beyond that is unclear. Big banks aren't increasing the net amounts of their loan portfolios and small businesses still limp along with working capital from their owners' credit cards. Real estate remains moribund, with more of the same expected for the future. Raising interest rates will make financial markets speculators unhappy. But let's remember that central bank manipulation of asset prices doesn't produce lasting prosperity, but indeed the opposite (for further reading, see 2007-08 financial crisis).
For all the political hoopla over deficits, reality is that money talks and bullsh . . . uh, political dialogue walks. What's forced Greece, Ireland, Portugal and other Euro bloc nations to rein in their spending? Not frowning bureaucrats in Brussels, but rising interest rates demanded by their creditors. Chairman Bernanke recently scolded Congress and the administration for not doing enough to reduce the deficit. Well, remember, Mr. Chairman, money talks and bu . . . well, you know. If you want the government to reduce the deficit, make it pay for borrowing.
Monday, April 18, 2011
Did the Fed Add to the Fall in Stocks?
Today, Standard and Poor's lowered its outlook on long term U.S. Treasury debt from "stable" to "negative". What happened? U.S. Treasuries went up in value.
Huh?
Market forces would have dictated that Treasuries should have fallen. In fact, they did drop immediately after the announcement. But then they rose, even while stocks fell. If anything, one would have expected stocks to do comparatively well. Investors might logically ditch Treasuries and buy stocks.
So what happened? One serious possibility is that the Fed was buying in the Treasury market big time today, as part of its quantitative easing program and perhaps as part of its open market operations as well. The last thing the Fed wants to see is a rise in interest rates. If a downdraft hits the Treasury market, the Fed would move quickly to counteract it.
All that's understandable, given the Fed's statutory mandate to maximize employment. But it's possible that the fast traders on Wall Street--which would be most of the market today-- saw an arbitrage opportunity. If you know the Fed will be a heavy buyer of Treasuries, then you'd think about ditching stocks to raise cash, buying Treasuries quickly when they first drop, and reselling them at a profit to the Fed as it revs up its buying. The smart traders on the Street like to take advantage of large buyers and sellers, who often provide such arbitrage opportunities. The really cynical smart money would, indeed, short sell stocks to profit from the expected downdraft. That, if it occurred, would have added to the downward spiral of stocks.
The Fed also doesn't want stocks to drop. That might cool the consumption of the well-to-do and hamper the economic recovery. But the Fed is a lumbering cow in a market full of wolves, and today's weird market action indicates the wolf packs were probably voracious.
Huh?
Market forces would have dictated that Treasuries should have fallen. In fact, they did drop immediately after the announcement. But then they rose, even while stocks fell. If anything, one would have expected stocks to do comparatively well. Investors might logically ditch Treasuries and buy stocks.
So what happened? One serious possibility is that the Fed was buying in the Treasury market big time today, as part of its quantitative easing program and perhaps as part of its open market operations as well. The last thing the Fed wants to see is a rise in interest rates. If a downdraft hits the Treasury market, the Fed would move quickly to counteract it.
All that's understandable, given the Fed's statutory mandate to maximize employment. But it's possible that the fast traders on Wall Street--which would be most of the market today-- saw an arbitrage opportunity. If you know the Fed will be a heavy buyer of Treasuries, then you'd think about ditching stocks to raise cash, buying Treasuries quickly when they first drop, and reselling them at a profit to the Fed as it revs up its buying. The smart traders on the Street like to take advantage of large buyers and sellers, who often provide such arbitrage opportunities. The really cynical smart money would, indeed, short sell stocks to profit from the expected downdraft. That, if it occurred, would have added to the downward spiral of stocks.
The Fed also doesn't want stocks to drop. That might cool the consumption of the well-to-do and hamper the economic recovery. But the Fed is a lumbering cow in a market full of wolves, and today's weird market action indicates the wolf packs were probably voracious.
Thursday, April 14, 2011
The Point Missed in the Budget Debate
It's become all the rage in Washington to froth over the federal deficit and produce sound bite-driven proposals on how to reduce it. In the relentless quest for media coverage, everyone involved in the budget debate has something accusatory to say about someone else. As in sports, trash talking and cheap shots get more attention than real accomplishments.
The lack of attention to real accomplishments allows an important point about the budget deficit to go unnoticed. When we talk about splitting up a pie, the size of the pie is crucial. A large, fast growing pie is much easier to divide than a smaller, slowly growing pie. A stagnant or shrinking pie can be poisonous to the debate. Right now, we have a slowly growing pie that may go stagnant or shrink soon given the rising costs of energy and food. And the debate is indeed poisonous.
We need to focus more on expanding the pie, not in the Federal Reserve short term-next quarter, money printing, inflation-risky way, but for the long term. We also can't look to the federal government to solve all our problems. At the risk of asking Americans to behave like adults, it would be better if we looked for some non-federal ways to boost long term economic growth. There is a limit to the effectiveness of federal policies, which are mostly subsidies and handouts, and we pretty much surpassed that limit a while ago. What should be done?
Embrace Innovation. Innovation was the key to America's spectacular growth in the past two centuries. Railroads, the telegraph, the telephone, the airplane, automation of farming, new energy technologies, electronics and computers were essential factors in making America an economic powerhouse. We celebrate the concept of innovation today, but don't encourage it enough. Immigration rules for the highly educated should be relaxed--we'll never recapture manufacturing from Asia, but we can try to bring more of their brainpower to America. Many of Asia's smartest people want to live here, at least for a while and maybe for the rest of their lives. Brains produce innovation; tariffs don't. America's economic future will be in the production of high value added goods and services. (And not, contrary to what the Fed thinks, a revival of housing, which can't be revived by the government because it remains buried under a crushing load of bad debt, and only politically unacceptable levels of taxpayer subsidies will revive housing.) Innovation was the key to America's past prosperity and will be the key to its future.
Hug nerds. America's educational system is roundly criticized for failing to teach many students the basics. That's a valid point, but we're too focused on making America's schools training facilities for corporate employers. Schools should also be a place for exploration and creative thinking. They're not. Today's elite universities' admissions standards place enormous emphasis on being well-rounded, having not only fantastic grades, but athletic achievement, public service, experience in the arts, internships left and right, and international travel. The people admitted will make good corporate executives, management consultants, corporate lawyers, accountants, and doctors. Those with good math skills may become Wall Streeters. Most likely, none will create innovative technologies or establish major businesses. It's not an accident that Bill Gates, Steve Jobs, and Larry Ellison were all college dropouts. (So was Mark Zuckerberg, although it's not yet clear if Facebook is a transformational company or a fad-and-fade like Yahoo.) America's leading universities don't embrace original thinkers; they favor compliant kids who know how to manipulate and please their elders. Today's elite schools don't encourage or even tolerate the wacked out thinking that transformational economic change requires. Gates, Jobs and Ellison had to swim upstream to accomplish what they did. One can only wonder how many dozens, hundreds and maybe thousands of other free thinking, but slightly less determined kids have been discouraged from fostering innovative change. We need to think outside the box to make America grow again, and one way would be to encourage, and indeed embrace, kids who think outside the box.
Improve transportation and communications. America is a big country. Look on a globe, and you'll find very few other countries as large. We need really good transportation systems, because ultimately goods and many services need to be physically delivered. One can't live off Internet access alone. State and federal governments in the 19th Century did a much better job in this respect than their counterparts today. The Erie Canal was sponsored by New York state. The railroads were subsidized by the federal government. In the 20th Century, air transportation and the interstate highway system were creations of federal policy, and local governments took on much of the burden of building suburban infrastructure. America became wealthy from the massive markets permitted by these government supported transportation systems. Today, highways need to be maintained, bridges repaired, and subway systems renovated and expanded. Suburban roads need maintenance and improvement--remember that most economic growth is in suburban areas, in spite of renewal in a few urban areas. Roads and other transportation systems don't have powerful lobbyists, so they are easily ignored. That is a serious mistake.
Fostering high-speed Internet access for all should be a priority. This would include hard wired access and wireless access. The easier it is to communicate, the more innovation we'll have. And, let's face it, the more consumption we'll have since we're approaching the point where you can buy almost anything over the Internet. Way too many people share way too much about themselves in the Internet. But speed of communication speeds up economic activity. Even if some people are tacky and tasteless, others will increase their productivity--and, along with it, our prosperity.
The lack of attention to real accomplishments allows an important point about the budget deficit to go unnoticed. When we talk about splitting up a pie, the size of the pie is crucial. A large, fast growing pie is much easier to divide than a smaller, slowly growing pie. A stagnant or shrinking pie can be poisonous to the debate. Right now, we have a slowly growing pie that may go stagnant or shrink soon given the rising costs of energy and food. And the debate is indeed poisonous.
We need to focus more on expanding the pie, not in the Federal Reserve short term-next quarter, money printing, inflation-risky way, but for the long term. We also can't look to the federal government to solve all our problems. At the risk of asking Americans to behave like adults, it would be better if we looked for some non-federal ways to boost long term economic growth. There is a limit to the effectiveness of federal policies, which are mostly subsidies and handouts, and we pretty much surpassed that limit a while ago. What should be done?
Embrace Innovation. Innovation was the key to America's spectacular growth in the past two centuries. Railroads, the telegraph, the telephone, the airplane, automation of farming, new energy technologies, electronics and computers were essential factors in making America an economic powerhouse. We celebrate the concept of innovation today, but don't encourage it enough. Immigration rules for the highly educated should be relaxed--we'll never recapture manufacturing from Asia, but we can try to bring more of their brainpower to America. Many of Asia's smartest people want to live here, at least for a while and maybe for the rest of their lives. Brains produce innovation; tariffs don't. America's economic future will be in the production of high value added goods and services. (And not, contrary to what the Fed thinks, a revival of housing, which can't be revived by the government because it remains buried under a crushing load of bad debt, and only politically unacceptable levels of taxpayer subsidies will revive housing.) Innovation was the key to America's past prosperity and will be the key to its future.
Hug nerds. America's educational system is roundly criticized for failing to teach many students the basics. That's a valid point, but we're too focused on making America's schools training facilities for corporate employers. Schools should also be a place for exploration and creative thinking. They're not. Today's elite universities' admissions standards place enormous emphasis on being well-rounded, having not only fantastic grades, but athletic achievement, public service, experience in the arts, internships left and right, and international travel. The people admitted will make good corporate executives, management consultants, corporate lawyers, accountants, and doctors. Those with good math skills may become Wall Streeters. Most likely, none will create innovative technologies or establish major businesses. It's not an accident that Bill Gates, Steve Jobs, and Larry Ellison were all college dropouts. (So was Mark Zuckerberg, although it's not yet clear if Facebook is a transformational company or a fad-and-fade like Yahoo.) America's leading universities don't embrace original thinkers; they favor compliant kids who know how to manipulate and please their elders. Today's elite schools don't encourage or even tolerate the wacked out thinking that transformational economic change requires. Gates, Jobs and Ellison had to swim upstream to accomplish what they did. One can only wonder how many dozens, hundreds and maybe thousands of other free thinking, but slightly less determined kids have been discouraged from fostering innovative change. We need to think outside the box to make America grow again, and one way would be to encourage, and indeed embrace, kids who think outside the box.
Improve transportation and communications. America is a big country. Look on a globe, and you'll find very few other countries as large. We need really good transportation systems, because ultimately goods and many services need to be physically delivered. One can't live off Internet access alone. State and federal governments in the 19th Century did a much better job in this respect than their counterparts today. The Erie Canal was sponsored by New York state. The railroads were subsidized by the federal government. In the 20th Century, air transportation and the interstate highway system were creations of federal policy, and local governments took on much of the burden of building suburban infrastructure. America became wealthy from the massive markets permitted by these government supported transportation systems. Today, highways need to be maintained, bridges repaired, and subway systems renovated and expanded. Suburban roads need maintenance and improvement--remember that most economic growth is in suburban areas, in spite of renewal in a few urban areas. Roads and other transportation systems don't have powerful lobbyists, so they are easily ignored. That is a serious mistake.
Fostering high-speed Internet access for all should be a priority. This would include hard wired access and wireless access. The easier it is to communicate, the more innovation we'll have. And, let's face it, the more consumption we'll have since we're approaching the point where you can buy almost anything over the Internet. Way too many people share way too much about themselves in the Internet. But speed of communication speeds up economic activity. Even if some people are tacky and tasteless, others will increase their productivity--and, along with it, our prosperity.
Monday, April 11, 2011
Corporate Earnings Will Be the Ball Game For Stocks
The headwinds in the stock market are rising. Government accommodation in major parts of the world is being dialed back. China is raising interest rates to cool growing inflation and a runaway economy. The Euro bloc is raising interest rates to combat inflation, in spite of a slow growing economy. Brazil is growing, but will have to battle serious inflation. Oil prices keep rising; $4 a gallon gas is a reality in most of the U.S., even if statistical averages haven't quite gotten there.
Black swans fill the air. Arab unrest has a whack-a-mole quality to it. No matter what is done to calm things down, eruptions get bigger and more widespread. Libya has stalemated, putting pressure on Western nations to join the ground war. Japan just elevated its nuclear crisis to Chernobyl status. And that's just the part the Japanese government has told us about. Considering that it hasn't been a paragon of transparency, one can only wonder what we don't know. Japan keeps having aftershocks that would qualify as big earthquakes anywhere else. Things aren't settling down there.
Portugal has just gone to the EU, hat in hand, to ask for a loan in the range of 80 billion Euros plus, following the path paved by Greece and Ireland. The Euro crisis is sliding downhill more or less as predicted. (Watercooler gossip has it that Spain will be next in line for a bailout.) As France takes the lead to spend Germany's money bailing out weaker EU nations, the markets snooze in the belief that creditors will be paid 100 cents on the Euro. Some day that won't be true. If you look at the Euro bloc as a whole, it's awash in debt. We have the lesson from the U.S. and other real estate markets that too much mortgage debt leads to bad things. That will also be true for sovereign debt.
The U.S. Federal Reserve is keeping its monetary printing press going 24/7. A majority of governors say they don't see any inflation, but would welcome it if it happened. That way, they can keep paying the print shop staff overtime no matter what. Meanwhile, back at the ranch, the poor consumer, whose wages aren't rising now or any time soon, is cutting back on driving while trying really hard to believe that beans and franks make a fine meal. Walmart just announced a return to every day low prices. That, as much as anything, tells you the consumer is under pressure. Since the U.S. economy is two-thirds consumption, the economy will soon be under pressure, too.
Stocks have more than doubled since their 2009 lows. Just about the only thing that can keep the bull running would be glowing corporate earnings. Alcoa was at the top of the order today, and whiffed. It reported greater earnings but disappointing revenues. Its stock is off about 3% in afterhours trading. Not a good beginning to the earnings season. If other companies follow Alcoa's lead, well . . . just tell yourself that beans and franks make a fine meal.
Black swans fill the air. Arab unrest has a whack-a-mole quality to it. No matter what is done to calm things down, eruptions get bigger and more widespread. Libya has stalemated, putting pressure on Western nations to join the ground war. Japan just elevated its nuclear crisis to Chernobyl status. And that's just the part the Japanese government has told us about. Considering that it hasn't been a paragon of transparency, one can only wonder what we don't know. Japan keeps having aftershocks that would qualify as big earthquakes anywhere else. Things aren't settling down there.
Portugal has just gone to the EU, hat in hand, to ask for a loan in the range of 80 billion Euros plus, following the path paved by Greece and Ireland. The Euro crisis is sliding downhill more or less as predicted. (Watercooler gossip has it that Spain will be next in line for a bailout.) As France takes the lead to spend Germany's money bailing out weaker EU nations, the markets snooze in the belief that creditors will be paid 100 cents on the Euro. Some day that won't be true. If you look at the Euro bloc as a whole, it's awash in debt. We have the lesson from the U.S. and other real estate markets that too much mortgage debt leads to bad things. That will also be true for sovereign debt.
The U.S. Federal Reserve is keeping its monetary printing press going 24/7. A majority of governors say they don't see any inflation, but would welcome it if it happened. That way, they can keep paying the print shop staff overtime no matter what. Meanwhile, back at the ranch, the poor consumer, whose wages aren't rising now or any time soon, is cutting back on driving while trying really hard to believe that beans and franks make a fine meal. Walmart just announced a return to every day low prices. That, as much as anything, tells you the consumer is under pressure. Since the U.S. economy is two-thirds consumption, the economy will soon be under pressure, too.
Stocks have more than doubled since their 2009 lows. Just about the only thing that can keep the bull running would be glowing corporate earnings. Alcoa was at the top of the order today, and whiffed. It reported greater earnings but disappointing revenues. Its stock is off about 3% in afterhours trading. Not a good beginning to the earnings season. If other companies follow Alcoa's lead, well . . . just tell yourself that beans and franks make a fine meal.
Tuesday, April 5, 2011
Roth IRA versus Traditional IRA: a Snapshot of Our Tax Dilemma
Should you have a Roth IRA or a traditional IRA? That's the question for many of today's savers. The answer illustrates a basic problem in America's system of taxation, one that doesn't appear likely to be fixed any time soon.
Traditional IRA. The more or less standard reasons for choosing a traditional IRA is that you can deduct the contributions now, and defer taxation until you begin withdrawals. Generally, speaking, you must wait until you're 59 and 1/2 before you can take withdrawals. You can defer withdrawals, though, and let your savings continue to grow on a tax-deferred basis until age 70 and 1/2. Then, you must begin to withdraw a minimum amount each year or face tax penalties.
You can contribute up to $5,000 a year in 2011 (or $6,000 if you're 50 or older), or the amount of your earned income, if less. You can deduct the contribution if you and your spouse (if you have one) aren't covered by an employer retirement plan. If either of you is covered by an employer retirement plan, the amount of your deduction in 2011 begins to shrink if your adjusted gross income is $56,000 or more (if single), or $89,000 or more (if married and filing jointly). To get a headache reading about the mindlessly complex rules concerning deductibility, go to IRS Publication 590 at http://www.irs.gov/publications/p590/ch01.html#en_US_2010_publink1000230433. Keep reading for a while, because the rules really do go on at some length.
The conventional wisdom is that a traditional IRA is good for people who can deduct all or most of their contributions, and are likely to fall into a lower tax bracket in retirement. In essence, the traditional IRA lets you "borrow" the taxes that would otherwise be due on the income contributed and use them for a while to generate investment returns. You'll pay taxes eventually, but eventually could be decades away. This is one of the few loans you can take that might actually make sense.
Roth IRA. The Roth IRA is funded with aftertax dollars, up to $5,000 a year (or $6,000 if you're 50 or over), or the amount of your earned income, if less. You get no deduction from your current tax bill. Note that the $5,000/$6,000 limit is a combined annual limit for all contributions to whatever traditional and Roth IRAs you might have. For example, if you have both types of accounts and contribute $2,000 to a Roth, you can't contribute more in the same year than $3,000 to the traditional IRA.
If you maintain the Roth for at least five years, you will be able to withdraw the earnings tax free beginning at age 59 and 1/2. However, you don't ever need to make withdrawals and can keep the money in the Roth accumulating tax free investment returns until the end of your life. In such circumstances, the beneficiaries you designate will be required to gradually withdraw the funds over their lives, but they won't need to pay income taxes on those withdrawals. The Roth account will be included in your estate for federal estate tax purposes, so it may be taxed in that way if you're well-off enough. But consider yourself fortunate if you have this problem. For those with a very long term perspective, the Roth is a good estate planning device.
The conventional wisdom is that a Roth IRA is good for people who expect to be in a tax bracket equal to or higher than the one they're in currently. That would mean that Roths are basically good for relatively high earners who expect to retire relatively well off. Another consideration is that Roths are administratively easier than traditional IRAs. You don't need to fuss with calculations of minimum annual withdrawals when you get older. You can take withdrawals as and when you choose, and they aren't taxed. Or you can pass the money along to your designated beneficiaries and they aren't taxed.
The Tax Dilemma. All this is well and good if you can reasonably predict what future tax rates will be. But the current modus operandi in Washington is to jury rig ad hoc short term tax provisions, where rates, deductions and other important aspects of the tax code have very limited half-lives. Most recently, the 2010 tax compromise between President Obama and the House Republicans resulted in a two-year tax cut program that will increase, rather than decrease, the federal deficit. So you can now plan as far as two years ahead. After that, it's anyone's guess where tax brackets will be. Realistically speaking, taxes will have to rise in order to bring deficits under control. But politically speaking, the likelihood of tax increases is low, but may be more likely for moderate and low income Americans than the well-off. (If you think I'm kidding, take a look at the 2010 tax compromise: the progressive $400 Making Work Pay credit was eliminated and a less progressive 2% point cut in Social Security taxes was substituted.)
When it comes to a choice between a traditional IRA or a Roth IRA, the bottom line is no one knows for sure what's best, and most likely you won't know in the future, either. Much of life involves operating on limited information in foggy conditions. One approach would be to split your contributions between a traditional and a Roth, thereby hedging your bets. Another approach is to use only a Roth. While it's more expensive to fund, a Roth is easier administratively on the back end--when you're 83 and juggling a half a dozen prescription medications, you won't want to fool around with the IRS formula for minimum required distributions from your IRA. And a Roth may be a beneficial estate planning tool if you want to leave money to someone else.
Note to the truly frugal. If you have a moderate or low income, you may actually be able to get a tax credit of up to $1,000 for contributions to a traditional or Roth IRA. The credit is available in 2011 only if your income is $55,500 if married and filing jointly, $41,625 if you file as a Head of Household, or $27,750 if single, married filing separately or a qualifying widow(er). This credit offers a dollar-for-dollar reduction of your tax liabilities, so it's worth claiming if you can (in essence, the government funds your IRA up to $1,000). It isn't easy to save at these income levels, but the 7 or 8 Americans who manage to do so can get a nice tax credit.
Traditional IRA. The more or less standard reasons for choosing a traditional IRA is that you can deduct the contributions now, and defer taxation until you begin withdrawals. Generally, speaking, you must wait until you're 59 and 1/2 before you can take withdrawals. You can defer withdrawals, though, and let your savings continue to grow on a tax-deferred basis until age 70 and 1/2. Then, you must begin to withdraw a minimum amount each year or face tax penalties.
You can contribute up to $5,000 a year in 2011 (or $6,000 if you're 50 or older), or the amount of your earned income, if less. You can deduct the contribution if you and your spouse (if you have one) aren't covered by an employer retirement plan. If either of you is covered by an employer retirement plan, the amount of your deduction in 2011 begins to shrink if your adjusted gross income is $56,000 or more (if single), or $89,000 or more (if married and filing jointly). To get a headache reading about the mindlessly complex rules concerning deductibility, go to IRS Publication 590 at http://www.irs.gov/publications/p590/ch01.html#en_US_2010_publink1000230433. Keep reading for a while, because the rules really do go on at some length.
The conventional wisdom is that a traditional IRA is good for people who can deduct all or most of their contributions, and are likely to fall into a lower tax bracket in retirement. In essence, the traditional IRA lets you "borrow" the taxes that would otherwise be due on the income contributed and use them for a while to generate investment returns. You'll pay taxes eventually, but eventually could be decades away. This is one of the few loans you can take that might actually make sense.
Roth IRA. The Roth IRA is funded with aftertax dollars, up to $5,000 a year (or $6,000 if you're 50 or over), or the amount of your earned income, if less. You get no deduction from your current tax bill. Note that the $5,000/$6,000 limit is a combined annual limit for all contributions to whatever traditional and Roth IRAs you might have. For example, if you have both types of accounts and contribute $2,000 to a Roth, you can't contribute more in the same year than $3,000 to the traditional IRA.
If you maintain the Roth for at least five years, you will be able to withdraw the earnings tax free beginning at age 59 and 1/2. However, you don't ever need to make withdrawals and can keep the money in the Roth accumulating tax free investment returns until the end of your life. In such circumstances, the beneficiaries you designate will be required to gradually withdraw the funds over their lives, but they won't need to pay income taxes on those withdrawals. The Roth account will be included in your estate for federal estate tax purposes, so it may be taxed in that way if you're well-off enough. But consider yourself fortunate if you have this problem. For those with a very long term perspective, the Roth is a good estate planning device.
The conventional wisdom is that a Roth IRA is good for people who expect to be in a tax bracket equal to or higher than the one they're in currently. That would mean that Roths are basically good for relatively high earners who expect to retire relatively well off. Another consideration is that Roths are administratively easier than traditional IRAs. You don't need to fuss with calculations of minimum annual withdrawals when you get older. You can take withdrawals as and when you choose, and they aren't taxed. Or you can pass the money along to your designated beneficiaries and they aren't taxed.
The Tax Dilemma. All this is well and good if you can reasonably predict what future tax rates will be. But the current modus operandi in Washington is to jury rig ad hoc short term tax provisions, where rates, deductions and other important aspects of the tax code have very limited half-lives. Most recently, the 2010 tax compromise between President Obama and the House Republicans resulted in a two-year tax cut program that will increase, rather than decrease, the federal deficit. So you can now plan as far as two years ahead. After that, it's anyone's guess where tax brackets will be. Realistically speaking, taxes will have to rise in order to bring deficits under control. But politically speaking, the likelihood of tax increases is low, but may be more likely for moderate and low income Americans than the well-off. (If you think I'm kidding, take a look at the 2010 tax compromise: the progressive $400 Making Work Pay credit was eliminated and a less progressive 2% point cut in Social Security taxes was substituted.)
When it comes to a choice between a traditional IRA or a Roth IRA, the bottom line is no one knows for sure what's best, and most likely you won't know in the future, either. Much of life involves operating on limited information in foggy conditions. One approach would be to split your contributions between a traditional and a Roth, thereby hedging your bets. Another approach is to use only a Roth. While it's more expensive to fund, a Roth is easier administratively on the back end--when you're 83 and juggling a half a dozen prescription medications, you won't want to fool around with the IRS formula for minimum required distributions from your IRA. And a Roth may be a beneficial estate planning tool if you want to leave money to someone else.
Note to the truly frugal. If you have a moderate or low income, you may actually be able to get a tax credit of up to $1,000 for contributions to a traditional or Roth IRA. The credit is available in 2011 only if your income is $55,500 if married and filing jointly, $41,625 if you file as a Head of Household, or $27,750 if single, married filing separately or a qualifying widow(er). This credit offers a dollar-for-dollar reduction of your tax liabilities, so it's worth claiming if you can (in essence, the government funds your IRA up to $1,000). It isn't easy to save at these income levels, but the 7 or 8 Americans who manage to do so can get a nice tax credit.
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