The Traditional IRA Trap

The first Individual Retirement Act was passed in 1974. This is a link to the history of the IRA.

The traditional IRA was designed to encourage savings. This was unnecessary. All the government mob had to do was not tax interest on savings and people would have saved.

The government does something for the sometimes obvious reasons. The unseen consequences of government actions are seldom considered. When people first heard of the IRA they thought the government was kind and magnanimous. The government was just responding to the request of Wall Street brokerage houses that were looking for a way to generate customers. The Wall Street crowd knew the IRA holders would need “custodians” for which the Wall Street crowd would receive a fee. That is why the IRA was created.

Interest, capital gains and other income in an IRA is not taxed. This is good for low income earners who withdraw the funds after retirement. However with high income and net worth, an IRA may not be so good. For a high wage earner the trap is that interest income and capital gains in a regular account may be taxed at a low rate of 20% while interest income and capital gains in an IRA is tax deferred. Tax deferred does not mean you will pay 20% tax on the income when you withdraw the funds. When you withdraw the interest that was earned you will now have to pay a higher tax rate on the withdrawn funds because the government mob has set a trap for you. When withdrawn the interest and capital gains income are treated by the government mob as if they are ordinary income, taxed at a higher rate than interest, dividends, and capital gains.

For the high income person with a large IRA balance he may be looking for high interest investments because the interest in his IRA is not taxed. However, when he withdraws these earnings they are taxed, at the higher rate of ordinary income. What the government giveth the government taketh away.

One of the unseen benefits to the government of creating IRAs was the estate tax, at the time higher than ordinary income. People who built up and estate through IRAs, remember you cannot take money out without a penalty before age 60, would have to pay an estate tax rate higher than ordinary income, and much higher than interest or capital gains.

The government mob also taxes the traditional IRA twice. First the heirs must pay estate taxes on the value of the IRA at the time of death. Then when they withdraw the remaining funds it is taxed as ordinary income.

The latest attempt to get business for Wall Street is the Roth IRA. I suspect that legislation was also written by the lobbyists of the financial industry.

“Morality is the custom of one's country and the current feeling of one's peers. Cannibalism is moral in a cannibal country”. -Samuel Butler, writer (1835-1902)

Charles Tolleson
September 23, 2010