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Is a Roth IRA or traditional IRA better for young workers?

Dear Liz: My mid-20s nephews and I discussed financial planning for them. After recommending they check with their employers for a 401(k) or equivalent program, we spoke about traditional versus Roth IRAs. Would younger investors benefit more from a Roth IRA because the length of time the money would be invested is so long that the eventual tax-free withdrawal of the earnings outweighs the initial tax benefits of a traditional IRA? At this time, we cannot determine if my nephews will have a higher tax rate post-retirement than now (even assuming income tax rates stay the same).

Answer: The usual advice has been that people should contribute to a Roth IRA rather than a traditional IRA if they expect to be in the same or higher tax brackets in retirement. (Contributions to Roths are not tax-deductible but withdrawals in retirement are tax-free. By contrast, contributions to traditional IRAs are often deductible, but withdrawals are taxed as income in retirement.)

Of course, you can’t predict future tax rates with any certainty. But it’s a pretty good bet that 20-somethings who are at the beginning of their careers will earn more — and thus face higher tax rates — down the road. In other words, your nephews’ current tax rates may be the lowest they’ll ever be. Your nephews may not get much benefit from a tax deduction now but could get huge benefits from tax-free withdrawals in the future.

Also, premature withdrawals from traditional IRAs are usually taxed and penalized, but you can always withdraw the amount you contribute to a Roth without paying taxes or penalties. That flexibility often appeals to young people who worry about “locking up” their money or who don’t yet have a substantial emergency fund.

Social Security is insurance

Dear Liz: My wife was 69 at the time of her passing. She was still working and not collecting Social Security. I am 72, retired and collecting Social Security. When I spoke with Social Security, I was told that I cannot collect on my wife’s Social Security. All I qualify for is a $255 death benefit. I asked what happened to her money that was collected all these years; I was told it goes into a general fund. Is there anything I can get from my wife’s Social Security?

Answer: If your current benefit is larger than the survivor benefit you would get based on her work record, then no.

Your question illustrates two common misconceptions about Social Security.

Social Security is not a 401(k) or other retirement fund that you pay into over time and then draw from in retirement. Social Security is actually insurance. (Social Security’s formal name is Old-Age, Survivors, and Disability Insurance, or OASDI.) It’s a pay-as-you-go system where the payroll taxes collected from current workers pay for the benefits received by people who are retired or disabled and their dependents.

The other misconception is that survivors are qualified for additional benefits on top of their own. In fact, survivors get the larger of the two benefits a couple was receiving — not both. This is, unfortunately, often a surprise to widows and widowers who see their incomes plunge after their partners die.

Vehicle insurance coverage limits

Dear Liz: You recently answered a question from someone who lent a van to a friend for more than a year. You mentioned the borrower “may have benefited from free insurance coverage if you continued to pay those premiums.” Some insurance companies limit the time they extend coverage when a car is driven by someone other than the owner or immediate family. Our insurance has a four-month limit.

Answer: That’s a good point. Insurers often require that anyone who regularly uses a vehicle be added to the insurance policy as a driver. In addition, someone who borrows a vehicle and who is otherwise uninsured might want to consider getting a non-owner insurance policy. This wouldn’t cover damage to the vehicle but would provide liability coverage in case of an accident.

Liz Weston, Certified Financial Planner, is a personal finance columnist for NerdWallet. Questions may be sent to her at 3940 Laurel Canyon, No. 238, Studio City, CA 91604, or by using the “Contact” form at asklizweston.com.

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