Roth v. Regular IRA and Tax Hedge

[Ima saver]

Re: Roth v. Regular IRA and Tax Hedge

I have both also because I started mine before the roth. I did not want to pay the taxes to convert, but I much prefer the roth ira.

[safari]

Re: Roth v. Regular IRA and Tax Hedge

I think Roth is more benefitial for the majority of people, regardless of their income, because with Roth you only pay taxes on the money that you contibute and then can withdraw both contributions and earnings tax free, while with a traditional IRA, you'll have to pay taxes on everything. Taking into account compound earnings, Roth IRA is a much better option in my opinion. For example, if you contribute $4,000 to Roth IRA for 30 years, you'll have contributed the total of $120,000, and you'll have paid taxes on the same $120,000. Assuming your investments will earn 12% a year, in 30 years you'll have $1,081,170 in your Roth IRA, which you can withdraw tax free. If you had a traditional IRA, you'd have to pay taxes on the entire $1,081,170, as opposed to $120,000 with a Roth IRA.

[sweeps]

Re: Roth v. Regular IRA and Tax Hedge

Safari, your numbers are misleading. It's true when withdrawing pre-tax money you have to pay taxes on the contributions and earnings. But the amount you're withdrawing is larger in the case of pre-tax money than the case of post-tax money. So there is no net difference.

Example here.

[LivingAlmostLarge]

Re: Roth v. Regular IRA and Tax Hedge

Thanks, I like the example. I'm going to write about it now.

[safari]

Re: Roth v. Regular IRA and Tax Hedge

Safari, your numbers are misleading. It's true when withdrawing pre-tax money you have to pay taxes on the contributions and earnings. But the amount you're withdrawing is larger in the case of pre-tax money than the case of post-tax money. So there is no net difference.

Example here.

Sweepsplayer, in your example you assume that a person can only contribute $1,000 a year to their retirement account. Of course in that case if you subtract the taxes, they'll end up contributing less money to a Roth IRA than they would to a traditional IRA. However, if a person wants to max out their contribution and deposit $4,000 to either IRA, your example is no longer valid. The limit that a person can contribue each year is the same for both types of IRA accounts. When someone makes a deposit to a Roth IRA, the taxes are not deducted from that deposit; the taxes have already been deducted from the paycheck. So in that scenario the amount that was deposited is the same, no matter what type of IRA account that person has chosen. Assuming the money was invested in the same mutual fund(s), when that person retires, he would be withdrawing the exact same amount, whether he chose a traditional or Roth IRA. The only difference would be that with a traditional IRA the whole amount would be taxable, while with a Roth IRA the whole amount would be tax-free since he already paid taxes on the money that he contributed. To summarize, if there were no yearly contribution limits, then the tax breaks (now and at retirement) would be the only factors that matter when choosing between the two types of IRA accounts, as you show in your example. However, for someone who wants to max out their contribution, Roth IRA is a no-brainer.

[sweeps]

Re: Roth v. Regular IRA and Tax Hedge

I agree that the $4,000 legal restriction on both IRA types would give the Roth the advantage. But taxation has nothing to do with it. You're ultimately contributing more money to your Roth than to your Traditional.

On a pre-tax basis, you may be contributing $4,000 to the Traditional. But you're contributing $5,000 or more to the Roth. That's an extra $1,000 or more of pre-tax money that you could spend and/or invest elsewhere.

A pre-tax 401k vs. Roth is a more fair comparison since obviously a 401k doesn't have the $4,000 restriction. Or if you want to limit it to Roth vs. Traditional, then you at least have to factor in that $1,000 or more per year of pre-tax money that is in the person's pocket in the case of a Traditional.

[tinapbeana]

Re: Roth v. Regular IRA and Tax Hedge

A pre-tax 401k vs. Roth is a more fair comparison since obviously a 401k doesn't have the $4,000 restriction. Or if you want to limit it to Roth vs. Traditional, then you at least have to factor in that $1,000 or more per year of pre-tax money that is in the person's pocket in the case of a Traditional.

then sweeps, the math would work out to 120k invested into the roth + 30k for taxes (1k per 4k contributed for 30 years based on your post), for a total investment of 150k.

using safari's example of 1,081,170 total after a 12% return for those 30 years, your 'return on investment' (total minus contributions and taxes already paid on contributions) = 931170 for a roth.

for a traditional, it would be 1,081,170 - 120k in contributions = 961170 - 8% (76893.60, est tax rate at retirement on the earnings) = 884276.40

the roth would net you 46893.60 more at the beginning of retirement. since both accounts are invested in identical funds in our hypothetical example, the yearly returns would be the same, and the roth would continue to 'outperform' the traditional simply because there would be no additional taxes taken out.

[sweeps]

Re: Roth v. Regular IRA and Tax Hedge

Honestly I didn't understand all that.

But again, comparing the results from a $4,000 pre-tax contribution and a $4,000 post-tax contribution is an apples-to-oranges comparison.

I don't dispute that a $4,000 Roth IRA contribution will net more than a $4,000 traditional IRA contribution. But that's because you're investing more with a $4,000 Roth IRA contribution than you are with a $4,000 traditional IRA contribution.

If you make an apples-to-apples comparison where you compare equivalent post-tax contribution amounts, it makes no difference whether you're taxed now or later.

[cptacek]

Re: Roth v. Regular IRA and Tax Hedge

Another thing I like about the Roth IRA is that you don't have to start taking money out of it at 72.5, like you do for a regular IRA. So, if your other investments are doing well (providing you with enough money to live on), you can leave that pot of money to give to your heirs, and once you pass on they don't have to take it all out at first either...they just have to take small contributions that will significantly increase the amount the gift is worth if they do it right.

If you have a 401k or 403b, you already have money that will be taxed when you take it out in retirement. So, if you then invest in a Roth IRA, you have tax diversification...some money will be taxed when you take it out, some won't.