Is the Roth right for you?

This year, it happened — something many have been predicting for years: Taxes went up. And most likely, the hikes will just keep coming. There's no other way to pay off the country's debt and fund the ballooning entitlements due the baby boomers as they retire. The increases may not affect everyone, and those who earn more will pay more, but someone's gotta pay.

One way to hedge against higher tax rates is to contribute to a Roth retirement account. Your contributions aren't tax-deductible, but the withdrawals are tax-free once you turn 59 ½ and you've had a Roth account for at least five years. Who wouldn't want tax-free money if tax rates are just going higher?

Well, as attractive as the Roth can be, it's not always the best choice for everyone. You see, a contribution to a Roth means you are forgoing a contribution to a traditional retirement account, which might give you a tax-deduction today in exchange for paying taxes in retirement. So the choice is: Should you pay taxes today or in retirement?

Here's the rule of thumb: If you're in a higher tax bracket today than you will be in retirement, stick with the traditional account. However, if you expect to be paying a higher tax rate in your golden years, go with the Roth. The same math applies when considering a “conversion,” which is turning a traditional account into a Roth. The amount in the traditional IRA that comes from deductible contributions or investment growth is taxed as ordinary income in the year of the conversion, but then it grows tax-free.

That's all handy-dandy, but there's one problem: While it's a safe bet taxes will go up, it's difficult to predict what that will mean for any given individual. Still, here are some considerations:

  • For many reasons, such as a drop in income, most people pay fewer taxes in retirement than they did while they were working. Plus, it's likely that senior citizens, as a group, will bear the smallest brunt of future tax hikes.
  • Make sure to factor in the difference in tax rates between the state where you currently live and the state to which you'll retire, if you plan to move.
  • A traditional vs. Roth calculation assumes that any tax savings from contributing to the traditional account is invested and saved for retirement. If you'll instead spend those tax savings, then the Roth looks much more attractive.

As an example, consider the situation of a Motley Fool reader, who posted his Roth conundrum on one of our discussion boards. He's in the 33 percent federal tax bracket, and pays a 9 percent state income tax to boot. It's possible he'll move to Texas after he retires, which is among the seven states that don't have an income tax. (The others include Florida and Nevada, also popular retirement destinations.) So if he were to contribute $10,000 to a Roth rather than a traditional account, he'd be giving up on a $4,200 tax deduction, factoring in both federal and state taxes. He's better off sticking with the traditional account, especially factoring in the possible move to Texas.

Sneaking in through the backdoor

The fellow can contribute to a Roth 401(k) because his employer offers the option. Otherwise, he'd be out of luck since his income makes him ineligible for a Roth IRA. Once you earn a modified adjusted gross income (AGI) of $112,000 if you're single or $178,000 if you're married, your ability to contribute gradually phases out.

However, all is not lost for those who don't have a Roth account at work, are ineligible for a Roth IRA, or have already maxed out their 401(k)s. It gets complicated, so stick with us.

First off, not all contributions to a traditional IRA are deductible. If you have a plan at work and are single with an AGI of $59,000 or are married and have an AGI of $95,000, your ability to deduct the contributions gets phased out. If you're above those income limits, you can make a nondeductible contribution to a traditional IRA. As the name implies, you can't deduct the contribution, but the investments still grow tax-deferred.

Now, here's where the Roth comes in. If you don't have any pretax money in traditional IRAs, including SEPs, SIMPLEs, and rollovers from prior employers' plans, you can immediately convert that traditional IRA to Roth. (And by “you,” we mean that you can ignore what your spouse has.) Here's the real bonus: Because you couldn't deduct the contribution and because the account didn't have an opportunity to grow, you won't owe any taxes on the conversion. This little trick has become known as the “backdoor Roth.”

It gets complicated if you have pretax money in a traditional IRA, since the amount is prorated across all the accounts for tax purposes. For example, if you have $50,000 in pretax IRAs, and then you make a nondeductible contribution of $5,000 to a traditional IRA and immediately convert that account to a Roth, only 10 percent ($50,000 divided by $5,000) will be tax-free. However, there's one possible way around this. You can transfer those pretax assets to your existing 401(k), if your employer allows it. The downside: 401(k)s have limited and often pricier investments, and most don't allow individual stocks and bonds.

Finally, based solely on the math, younger people in the 15 percent or lower tax bracket who expect to build up a large portfolio over their careers should choose the Roth.

Other benefits of the Roth

That's the math. But there are other perks to the Roth that might tip the scales in its favor if the math is fuzzy.

  • Contributions to a Roth IRA – not earnings – can be withdrawn tax- and penalty-free before age 59 1/2. This has its downsides, since it makes it more tempting to spend money that should be left for retirement. But there are some proponents of using the Roth IRA as a college savings account, and even an emergency fund.
  • Unlike the traditional IRA and 401(k), the Roth IRA does not have required minimum distributions (RMDs) at age 70 ½. The Roth 401(k) does, but you can transfer the money to a Roth IRA after you retire to get around RMDs.
  • Anyone who inherits a traditional IRA will have to pay ordinary income taxes on the distributions. However, the Roth account will still maintain its tax-free status. And nothing says “I love you” like giving someone tax-free retirement savings. (However, all retirement accounts are included in the calculation of whether estate taxes are due.)

The bottom line

We know the direction of tax rates (i.e., up), but we don't know the magnitude and the targets. They're decided by Congress, and who knows what those folks will do? Of course, they didn't put themselves in office, which means the decision ultimately lies with the voters — and they can be even crazier. Some people argue that we can't even assume that distributions from a Roth will remain tax-free. But just as diversification is important in your portfolio, tax diversification can also make sense. For many retiree wannabes, one way to hedge against future significant tax increases is to have at least some assets in a Roth account.

More about...Investing, Retirement

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Thomas | Your Daily Finance
Thomas | Your Daily Finance
7 years ago

I never really figured out which I should have put my money in so I actually decided to just max out my 401k and Roth. It made it easier plus since I live in Florida now and have no idea where we will be i didn’t want to guess wrong. Sure we have plans to stay in FL now but that could all change later down the road. A little diversification goes a long way.

Chris
Chris
7 years ago

Would love some help figuring out my situation. I am under 30 years old. I will make an even $120k in income this year.

I am currently on pace to contribute the max to my traditional 401K. If I do so, it seems that my MAGI has been reduced to $102.5k and I believe I should have no issues contributing the max to my roth IRA.

Is this accurate, or am I foolishly misunderstanding my tax situation?

Matt Becker
Matt Becker
7 years ago

The mistake most people make when doing this analysis is comparing their current tax bracket to their expected tax bracket in retirement. The real comparison is your current tax bracket to your effective tax rate in retirement. What I mean is that if you contribute to a traditional account today, your tax savings are determined by your current tax bracket. So if you’re in the 25% tax bracket, you will save 25% of your contribution from taxes (assuming you aren’t right on the line between brackets). But when you withdraw the money in retirement, it’s not all taxed at a… Read more »

Johanna
Johanna
7 years ago
Reply to  Matt Becker

Actually, that’s not quite right either. If your marginal tax rate in retirement turns out to be higher than your marginal tax rate today, then you would have been better off if you’d put some portion (not necessarily all) of your retirement savings in a Roth account rather than a traditional one. Ideally, what you should be aiming for is this: Have just enough money in a traditional account so that when you’re retired, you can take advantage of all available deductions, exemptions, and tax brackets less than what you’re currently paying now; any retirement savings in excess of that… Read more »

Ross Williams
Ross Williams
7 years ago
Reply to  Johanna

“if your income tax liability today is more than $0, it’s almost certainly a good idea to be putting some money in a traditional account. ” Its certainly a good idea for your money manager, whether its good idea for you is a different story. One of the problems is that the limits on retirement savings are the same for a Roth and a traditional IRA. If your tax bracket is 25% both now and in retirement, saving the maximum in both will result in 25% less money for you to spend in retirement. You can, as the article above… Read more »

Matt Becker
Matt Becker
7 years ago
Reply to  Johanna

That’s a good point Johanna about getting it technically optimal. Honestly, the reason I choose to mostly ignore that point is because, like you say, to get it right you have to be psychic. I think the biggest thing that people miss is the marginal vs. effective comparison, which is somewhat easier to compare. In response to both Johanna and Ross, I agree that diversification is important. Ross, you can say that most people won’t invest the tax savings from going the traditional route, but that doesn’t mean it shouldn’t be brought up as an option when trying to determine… Read more »

Ross Williams
Ross Williams
7 years ago
Reply to  Matt Becker

Whether you come out ahead investing your tax savings depends on your other investment options. If you have $6000 to save and put that $6000 in a traditional IRA and you will get the same return as paying the $1500 in taxes and placing the remaining $4500 in a Roth IRA. But if you have $8000 to save, you invest $6000 in a Roth IRA and pay $2000 in taxes. But you can still only invest $6000 in the traditional IRA. So the $2000 remaining, your tax savings, would have to be invested in a taxable account. You will likely… Read more »

Ross Williams
Ross Williams
7 years ago
Reply to  Matt Becker

To clarify the above, you only get a $6000 deduction for the traditional IRA contribution. So you will still have to pay taxes on the remaining $2000 and will have $1500 left to invest elsewhere.

Matt Becker
Matt Becker
7 years ago
Reply to  Matt Becker

Actually, even if in the situation you describe, where you max out your traditional IRA ($5500 for 2013) and invest the rest in a taxable account, that can still come out ahead of simply maxing out your Roth. There are plenty of variables, but the point remains that there are advantages to a traditional that many people skip over when extolling the virtues of a Roth.

And on your last point, if you save $2,000 in taxes by going with a traditional, you have that entire $2,000 to invest. It’s not extra income, it’s less taxes, which is different.

Ross Williams
Ross Williams
7 years ago
Reply to  Matt Becker

Matt – No, you don’t have $2000 to invest, you have to pay $500 in taxes on that $2000. $8000 to spend $2000 taxes on $8000 Invest remaining $6000 in Roth $8000 to spend Invest $6000 in tax deductible IRA $500 taxes on remaining $2000 after deduction $1500 left to invest in taxable account On withdrawal: Roth IRA $6000 + earnings Traditional IRA $4500 + 75% or earnings To get the same amount of money, The $1500 in taxable savings needs to generate net returns after taxes equivalent to the same rate as your tax deferred account. That is actually… Read more »

Matt Becker
Matt Becker
7 years ago
Reply to  Matt Becker

Just seeing your response now, and it is a good point that I missed on not having the full $2000 to invest. Thanks for the clarification.

Your “on withdrawal” calculation still assumes that the traditional IRA is taxed all at the margin, which may or may not be the case. There is a more complicated analysis needed and the end result with differ for each individual’s situation.

Derek | MoneyAhoy.com - Money Saving, Making Money, and Investment Ideas
Derek | MoneyAhoy.com - Money Saving, Making Money, and Investment Ideas
7 years ago

What’s the max you can put in a traditional vs. Roth IRA?

I know for 401K it is $17,500 for 2013.

This kinda stuff BEGs for a table to remove the confusion!

Matt Becker
Matt Becker
7 years ago

For a 401(k), whether Roth or Traditional, the max employee contribution is $17,500. For an IRA, once again whether Roth or Traditional, the max is $5500. There are also catch-up allowances if you are over 50.

Tom
Tom
7 years ago

I think its sort of a fool’s game to say “If you expect to be in a higher income bracket later…” – It isn’t possible to know that, so you’re either speculating: 1. End of the world scenario that the evil government jacks up everyone’s rates (yet leaves Roths untouched) 2. You somehow double your taxable retirement income relative to your non-retirement income. I believe someone who saves like this is unlikely to inflate their lifestyle considerably upon retirement. The middle three quintiles of income earners in America have an average income before taxes between $42,000 and $94,000. The effective… Read more »

Matt Becker
Matt Becker
7 years ago
Reply to  Tom

In Step 3 of your suggested plan, it seems like you’re comparing capital gains rates to the income tax rates you will face with a traditional 401k. This is an incorrect comparison. In a taxable account, the money going in has already been taxed, so you have to factor that in as well. And again, with a traditional account, it’s the effective tax rate that matters, not the marginal rate. There are situations where a taxable account may be preferable to a traditional 401k, but you have to consider the whole picture.

Tom
Tom
7 years ago
Reply to  Matt Becker

My assessment wasn’t really based on the best tax strategy (impossible to predict, as I originally stated) but my idea of the best investment diversification. I think the access of taxable accounts for people who save a lot of money, and perhaps won’t work until 59.5, is a big draw. I agree with your first point. The fact that its taxed initially (and perhaps, ongoing, if you receive dividends) is a consideration. I’m not sure I follow your second point, since capital gains are a way to lower your effective tax rate. The tax rate on capital gains for income… Read more »

Sam
Sam
7 years ago

We max out our 401ks at work. I have both a traditional 401k and a Roth 401k, I do 2/3 traditional and 1/3 Roth in my 401k up to the max ($17,500). No match. Mr. Sam has a great match, he puts everything into his traditional 401k. We have, for the last few years maxed out our nondeductible IRAs ($5,500 this year for each of us). When it became legal for us to convert traditional to Roth we did so and then we have contributed and converted since then. Since our IRAs are non deductible it, to me, wouldn’t make… Read more »

ris
ris
7 years ago

“You see, a contribution to a Roth means you are forgoing a contribution to a traditional retirement account…” Actually, I have both, which might be more common than you think.

John S @ Frugal Rules
John S @ Frugal Rules
7 years ago

Thanks for this post! I think it’s quite easy to fall under the assumption that a Roth is the only way to go and it should be done blindly. Like any other investment decision there needs to be some due diligence done to make sure it fits your needs. I tend to be of the opinion that both are good to have, if you can have them, so you can benefit from any possible tax diversification.

lmoot
lmoot
7 years ago

I am so glad this article happened. I have a question that has been burning for several years, but I’ve never been able to find an answer. How is the tax rate you’ll pay calculated at the withdrawal of a traditional retirement account (trad IRA, 401k, etc)? For example, if you worked as a high-power executive for many years, staying at the top rung of the tax bracket, and steadily put money into a tax-deferred account, then quit your job 2 years before retirement to work part time as a florist, putting you in the bottom rung of the tax… Read more »

Johanna
Johanna
7 years ago
Reply to  lmoot

No, and I’m not sure why you’d think that you would.

Your tax rate in retirement is calculated the same way as your tax rate pre-retirement: based on the amount of your taxable income. Taxable income includes earned income, dividends and interest on taxable accounts, withdrawals from traditional retirement accounts, and various other income sources.

lmoot
lmoot
7 years ago
Reply to  Johanna

Thank you, that has cleared up it up. As much reading as I do about retirement accounts, I’ve never been able to comprehend the 401k. So, you don’t get the taxes taken out at the withdrawal? You instead get taxed at the end of the tax year, in which you have to add what you withdrew that year from your 401k + any other income you earned? I was under the impression that they automatically took the tax out BEFORE you get the amount you withdrew, but then how could they do that until they know what total income you’ve… Read more »

Tim
Tim
7 years ago
Reply to  lmoot

lmoot, Distributions from a 401k should be like any other non-wage income: no taxes are deducted, and you’re responsible for paying the appropriate amount of tax. For most people, if you will owe more than $1,000 in taxes at the end of the year, you need to make estimated quarterly tax payments. To calculate this amount, you need to estimate what your income will be for the year, and pay the appropriate amount of tax. When April 15 comes along, you use the income you actually received to figure your tax, and either get a refund or owe more depending… Read more »

lmoot
lmoot
7 years ago
Reply to  Johanna

Thank you everyone. That really does clear up so much for me. Wow, I really had no idea how 401k’s worked. Maybe when I go back and read all those articles it will make a little more sense now. Makes me wish I’d asked years ago. So, what I’m gathering from the responses is that it’s best to have ALL of your debts, mortgages, loans, etc PAID before you retire so that you can maintain your lifestyle at a lower tax bracket. The more money you need to take out, potentially the higher the tax bracket. I contribute to the… Read more »

Lucas
Lucas
7 years ago
Reply to  lmoot

Yes you can 🙂 That is one of the less understood aspects of extreamly early retirement. If you make good money and can pump it into a 401k you save a ton on taxes. Then if you only need a very small salary to live off of you are close to tax free on the withdraw. You can setup a SEPP plan to pull money out of a IRA/401k before you are “retirement” age and then use what you need and put the rest into a roth or even another tax defered IRA (as long as it isn’t the same… Read more »

Ross Williams
Ross Williams
7 years ago
Reply to  Lucas

You can’t put money into an Roth or Traditional IRA unless you (or your spouse) have earned income. So if the money from your SEPP is your only income, you aren’t eligible for an IRA.

Ross Williams
Ross Williams
7 years ago
Reply to  lmoot

The answer is yes, sort of. He will be taxed at the marginal rate for the combined income from his florist job and whatever money he withdraws from tax deferred accounts. To maintain his previous income, he is going to end up paying some taxes at the higher rate he paid when he saved the money. But he will pay a lower rate on money he withdraws before his combined income gets to that higher marginal rate. Looked at another way, he would end up paying a very high tax rate on that florist income. Its the nature of marginal… Read more »

Mike@WeOnlyDoThisOnce
7 years ago

I would advocate for that cut off being slightly lower, even. You make great points here.

Lucas
Lucas
7 years ago

Both are good 🙂

IRA/401k you get the tax benefit at your marginal rate

ROTH – you get tax benefit closer to your average rate (is difficult to predict).

HSA – you get tax benefit now and later (like a supper roth).

So my approach right now based on my tax situation and prediction in retirement
1) max 401k
2) max HSA
3) max Roths
4) other taxables

Jake @ Common Cents Wealth
Jake @ Common Cents Wealth
7 years ago

This is a great overview. I’ve thought a lot about this topic recently and have come to the conclusion you stated near the end of your article, I’m going to do a bit of both. We don’t know where taxes will be when we retire (especially being that it’s 40 years away for me), so diversifying yourself is probably the best option.

Barbara Friedberg
Barbara Friedberg
7 years ago

Do whatever you can to contribute to a ROTH IRA. The benefits are outstanding. I recommend contributing more than you can afford to retirement, after awhile you will not feel the pinch. Start with workplace retirement account to get employer match, next contribute to a ROTH.

Ross Williams
Ross Williams
7 years ago

“There’s no other way to pay off the country’s debt and fund the ballooning entitlements due the baby boomers as they retire.” That cliche isn’t really true if its applied to taxes paid on retirement savings. In fact, it isn’t true in any sense since there is no reason to think we will need to “pay off the country’s debt” in anyone’s lifetime. We have, after all, been in debt almost continuously since we borrowed money to fund the revolutionary war. Moreover, changes to income tax rates are likely to have a marginal impact on the question of whether a… Read more »

Mrs PoP @ Planting Our Pennies
Mrs PoP @ Planting Our Pennies
7 years ago

We look at it as a hedge, and are lucky to be in the situation where this year we should be maxing out our 401Ks at work and contributing the max to our Roth IRAs. Our marginal income tax bracket is 25%, and we don’t have any state income taxes (FL, yay!), and it wouldn’t shock me if we move somewhere with state taxes in the next 30 years. Also, in my gut I just don’t see the income brackets keeping up with inflation long term as that would be an easy way to increase tax revenue without it looking… Read more »

interchangefinancial
interchangefinancial
7 years ago

Knowing what to do with your money is important, especially when it comes to your retirement. Whether or not Roth is ideal for you depends on your financial situation, but one thing is for sure, you can no longer afford to throw all of your savings into one account or strategy. Diversity is key!

Educators Credit Union
Educators Credit Union
7 years ago

Thanks for the great advice! Its hard to know exactly what the best decision for you is at this time but, good to prepare.

TripleE
TripleE
7 years ago

Stupid question that I didn’t see answered. . . If I have a Roth now, and decide down the road in a couple years that it’s a bad idea, or no longer meet the income requirements, can you move that to a traditional?

Ross Williams
Ross Williams
7 years ago
Reply to  TripleE

Not in a couple years and there is absolutely no reason you would want to. You can change your mind for contributions for the current tax year when you file your income tax return.

If you want to make tax deferred contributions to your retirement you can open a traditional IRA in addition to your Roth.

The income limits only apply to contributions you make in years where your income exceeds the limit. It has no effect on past contributions.

Waverly
Waverly
7 years ago

Awesome! Now I just need a working crystal ball to help me figure out A) my income before I retire and B) where I’ll live in retirement. Shouldn’t be too hard — it’s only 33 years away.

Tim
Tim
7 years ago
Reply to  Waverly

Your crystal ball probably doesn’t have to be quite as clear as you think. If you’re in a career with small, steady raises that may or may not keep up with inflation then you’re likely better off with a traditional IRA. If you’re in a job where you’re likely to get a promotion and significant raise at some point (i.e. one that bumps you up into a higher tax bracket), then you’re likely better off with a Roth for now, then switching to a traditional once you’re in a higher tax bracket.

bobj
bobj
7 years ago

“There’s no other way to pay off the country’s debt and fund the ballooning entitlements due the baby boomers as they retire”
.. lots of people forget that the boomers funding social security for most of their lives.

Tim
Tim
7 years ago
Reply to  bobj

That’s true, though they also paid lower income taxes than would otherwise be required because of the surplus from Social Security.

Ross Williams
Ross Williams
7 years ago
Reply to  Tim

Some people had lower income taxes because of the extra Social Security taxes, but probably not the same people in the same proportion to the amount they paid in extra Social Security taxes. Social Security is the classic “flat tax”, at least until you get over $100,000 in wages. There are no loopholes, no credits and no deductions.

Tim
Tim
7 years ago
Reply to  Ross Williams

Sure, but the person I responded to was talking about the “boomers.” Who paid how much varied, but there’s no question that the generation as a whole paid less in income taxes because of the excess Social Security taxes they paid.

Ross Williams
Ross Williams
7 years ago
Reply to  Ross Williams

That benefit from excess social security taxes was not limited to “boomers”, it applied to anyone who paid taxes including some who were receiving benefits.

Remember, the bulk of the “boomers” social security taxes went to pay benefits to the previous generation. In the same way each following generation pays the previous generation’s benefits.

Kyla
Kyla
7 years ago

Is a regular Roth IRA and an employer-sponsored Roth 401(k) separate in terms of contribution limits? I want to max out my Roth IRA this year ($5,500), so if I do this, will I be able to contribute additional money to my Roth 401(k) through my employer?

Jackie
Jackie
7 years ago
Reply to  Kyla

Yup, they’re separate. I contribute to my employer’s 401k plan (just up to the matching amount, but I could do more if I wanted), and I also recently opened up a Roth IRA on my own, which I plan on maxing out ($5,500) this year.

Becky
Becky
7 years ago

Check out Usiere Uko’s latest book, “Practical Steps to Financial Freedom and Independence: Your Road Map to Exiting the Rat Race and Living Your Dreams.” It is both an inspiring and practical book that I think everyone wanting to have success with their financial future, should read.

http://www.financialfreedominspiration.com/

Cathy Vazquez
Cathy Vazquez
7 years ago

2 years ago I started maxing out my annual 403B contributions and was able to open an IRA with 5,000$ that I immediately converted to a Roth. Does anyone know if I can continue to contribute to this account with after tax income whenever I want or once I converted do I have to leave it alone?

Dan
Dan
7 years ago
Reply to  Cathy Vazquez

Depends on your income – if you are over the Roth Contribution limits, you will have to do the non-deductible IRA, then convert again.

Crystal
Crystal
7 years ago

We sort of do both. Before self-employment, I had a 401k and a Roth IRA. Now we both just have Roth IRA’s and are looking into opening a SEP IRA. Our plan is to take out the max allowed for the minimum tax bracket in retirement and fill in any blanks with the Roth IRA withdrawals so we don’t bump ourselves into a higher tax bracket. That works, right?

TheeGooch
TheeGooch
7 years ago

Reasons to go with Trad. IRA – 1) you are sure to get the benefit.Taxes are trending up now, but tomorrow? In 10 years? In 40 years ? Who knows. 2) Government programs are not guaranteed – just like social security by the time you are able to use your IRA, legislation may have changed the game considerably . why take that risk when you don’t have to? I’d much rather take the bird in my hand than hope the grab the 2 in the bush:) The moment the government says ‘trust us, your money is safe’ it’s time to… Read more »

Ross Williams
Ross Williams
7 years ago
Reply to  TheeGooch

“1) you are sure to get the benefit” What benefit is that? Having those taxes in your account may make your balance larger, but they are only deferred. Uncle Sam is going to get those taxes and any earnings you get from them as soon as you withdraw any money from the account. With the Roth IRA the taxes are already paid and you get to keep all the money you earn. The real advantage of the traditional IRA is that you have put off the day of reckoning. You might get lucky, taxes may be lower in the future.… Read more »

Brophtron
Brophtron
7 years ago

The thing that you left out of your analysis is growth. If my investments appreciate considerably (one fund I bought is up more than 4X from what I bought).

Now, granted, growth can’t be guaranteed, but I’d rather pay tax on the initial investment than pay tax on 4X the value later – a 0 tax rate beats out any difference between 25 and 28.

Ross Williams
Ross Williams
7 years ago
Reply to  Brophtron

Brophton –

“I’d rather pay tax on the initial investment than pay tax on 4X the value later ”

It doesn’t matter which you do. If you didn’t pay taxes in advance, you would have more invested and it would all grow by 4X. You will have 4X as much money to pay the deferred taxes. That’s why investing the tax savings is critical to making the traditional IRA equivalent to a Roth IRA.

Brophtron
Brophtron
7 years ago

“If you didn’t pay taxes in advance, you would have more invested and it would all grow by 4X.” Says who? The limit is $5,500 this year whether I put it in a traditional or Roth IRA. So what if I pay taxes, I can afford to invest to the cap. Why would I be “investing less”? I take money from my checking account, write out $5,500, then decide what I want to invest in – the starting investment is the same. “You will have 4X as much money to pay the deferred taxes.” But why pay the taxes at… Read more »

Ross Williams
Ross Williams
7 years ago
Reply to  Brophtron

“I take money from my checking account, write out $5,500, then decide what I want to invest in — the starting investment is the same.” And if you have a Roth you also write out a check for the taxes. If you put $5500 into a Traditional IRA, you pay no taxes and can invest that money instead. Assuming you put all the money in the same investments and your tax rates are the same when you take the money out, your net will be the same. Of course, you won’t get any tax breaks on that extra investment in… Read more »

Brophtron
Brophtron
7 years ago
Reply to  Ross Williams

“And if you have a Roth you also write out a check for the taxes. If you put $5500 into a Traditional IRA, you pay no taxes and can invest that money instead.” You didn’t specify that it was for a non-retirement account, which would be a taxed account regardless of which retirement type I used. $1,000 or so per year won’t seriously affect how much I put into a brokerage account. But I don’t write out a check for my taxes – it’s just taken out of my paycheck each month regardless of which IRA account I choose, after… Read more »

Ross Williams
Ross Williams
7 years ago
Reply to  Brophtron

Actually the math is easy, but I can’t do it for you. Here are how it would have worked for me last year: $8500 to spend $6000 in Roth IRA $2500 in taxes at 25% marginal rate Assume that my investments in the Roth double by the time I withdraw, I will have $12000 $6000 in Traditional IRA $2500 saved in taxes used to buy a stock fund that pays no dividends. Assume again that my investments double and that my marginal tax rate is the same 25% when I withdraw. $12000 from IRA – $3000 in Taxes for a… Read more »

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