Despite Consumer Confidence Growth, We Still Fear Tax Hikes

According to a recent report from Bloomberg News, “the number of Americans saying the U.S. economy is getting better rose in March to the highest level since 2004 as a decline in claims for unemployment benefits offered more evidence of a labor-market recovery.”

The Labor Department showed jobless claims had decreased by 5,000 to 348,000 last week. That number represented the lowest since February 2008.

Despite those positive numbers, the fear of tax hikes coming down, and coming down soon, has consumers running scared.

Economic prognosticators are sure those tax hikes are coming soon due to tax cuts, wars, the recession and our growing population of retirees. Plus the federal government continues to spend more than it takes in.

These same experts say that in 2013 the top U.S. income bracket will go from paying 35% to almost 30%.

Tax Hike Fear Fueling Roth IRAs

Already the most popular retirement saving product, holding $4.7 trillion in assets as of the end of 2010, according to Mintel Market Research, Roth IRAs are gaining popularity as consumers look for savvier ways to protect their money.

Now read this breakdown from Ross Kenneth Urken on why consumers are doing the flocking to Roth IRAs:

The Roth Individual Retirement Arrangement is a retirement plan that allows you to withdraw money tax-free in retirement. That contrasts with traditional IRAs and retirement plans, that let you deposit pre-tax funds, but tax your withdrawals.

Now, in a traditional IRA, you can deduct your contribution (up to $5,000 annually) from your taxable income. But let’s think about the future.

There’s an old business school trick called the Rule of 72 for estimating how many years it will take for an investment to double: Divide 72 by your average return on investment percentage, and you have a rough answer. So, if someone earns 8% on a Roth IRA, — 72/8 = 9 — their money will double every 9 years. Thus, $5,000 invested at age 30 will become $10,000 at 39, $20,000 at 48, $40,000 at 57 and $80,000 at 66. If that were a traditional IRA, the investor would then have to pay income taxes on the $80,000.

With the Roth, you don’t get a deduction for your contribution, so you pay the taxes on the initial $5,000 you put in. Your investment grows the same way, but when you take money out, it’s tax free. Basically, you’re choosing between paying taxes on the seeds or on the crops.

The crux of the matter comes down to people’s belief that taxes will continue to increase. Based on that premise, it’s better to pay the taxes on your initial investments now, while rates are lower, than to wait and pay a higher rate on your total returns when you remove the money at retirement.

Bottom line – your Roth is never going to be taxed again, has capital appreciation as long as it grows and you get it back tax free. This means even more to younger workers who are unsure that Social Security will be available to them once they retire.

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What do you think? Do you have a Roth IRA? How are you feeling about the economy in 2012?

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