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Posted by Victor Roberts on April 12, 2007, 12:44 am
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I've been thinking about the value of a traditional vs. Roth
IRA for my sons, who are just starting out. In the process
I came to the conclusion that one is not automatically
necessarily better than the other, even for young people. In
fact, given two simple assumptions, both types of IRAs give
EXACTLY the same results upon retirement. Under these
assumptions, the "tax-free accumulation" advantage of the
Roth is balanced by the tax-deductible feature of the
Traditional. So this is yet another decision where the
"right" answer is "it depends" and the facts necessary to
make the right decision do not exist, since they lie in the
future.
Assumptions:
1) A fixed amount of pre-tax money to fund the IRAs. Say
$3000.
2) The same marginal tax rate now and when the person
retires. Say 20% for this discussion.
If a Traditional IRA is opened with $3000 at 5% APR,
compounded monthly, it will grow to $13,403.23 after 30
years. After 20% income tax, the IRA will be worth
$10,722.59.
If the same $3000 is used for a Roth, the taxpayer first has
to use $600 of the $3000 to pay the taxes on the $3000 that
is not being deducted from his or her income, so they get to
invest $2400 in their Roth IRA. After the same 30 years at
the same 5% this grows to the same $10,722.59.
Of course, if $3000 is invested in a Roth it will be more
valuable after 30 years than $3000 invested in a
Traditional, but this is not a fair comparison since the
funds used to pay the current income tax on the $3000 are
not being accounted for.
--
Vic Roberts
Replace xxx with vdr in e-mail address.
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<< The foregoing was not intended or written to be used, >>
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<< to this newsgroup as well as our anti-spamming policy >>
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Posted by Phil Marti on April 12, 2007, 6:51 pm
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> I've been thinking about the value of a traditional vs. Roth
> IRA for my sons, who are just starting out. In the process
> I came to the conclusion that one is not automatically
> necessarily better than the other, even for young people.
Rather than their age, I think the "starting out" aspect
weighs in favor of Roth during the early years of their
careers. All of this requires a reliable crystal ball to
some extent, but one thing I think will hold true is that
income taxes will remain progressive. Thus a tax deduction
has less value early on that it will later in life.
An extreme example is a dependent student working part time
and earning less than the dependent's standard deduction.
There would be no tax benefit from a traditional
contribution and all those years of tax-free accumulation in
a Roth.
--
Phil Marti
Clarksburg, MD
<< ======================================================= >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2006) - All rights reserved. >>
<< ======================================================= >>
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Posted by Shyster1040 on April 12, 2007, 6:51 pm
Please log in for more thread options > I've been thinking about the value of a traditional vs. Roth
> IRA for my sons, who are just starting out. In the process
> I came to the conclusion that one is not automatically
> necessarily better than the other, even for young people. In
> fact, given two simple assumptions, both types of IRAs give
> EXACTLY the same results upon retirement. Under these
> assumptions, the "tax-free accumulation" advantage of the
> Roth is balanced by the tax-deductible feature of the
> Traditional. So this is yet another decision where the
> "right" answer is "it depends" and the facts necessary to
> make the right decision do not exist, since they lie in the
> future.
>
> Assumptions:
>
> 1) A fixed amount of pre-tax money to fund the IRAs. Say
> $3000.
>
> 2) The same marginal tax rate now and when the person
> retires. Say 20% for this discussion.
>
> If a Traditional IRA is opened with $3000 at 5% APR,
> compounded monthly, it will grow to $13,403.23 after 30
> years. After 20% income tax, the IRA will be worth
> $10,722.59.
>
> If the same $3000 is used for a Roth, the taxpayer first has
> to use $600 of the $3000 to pay the taxes on the $3000 that
> is not being deducted from his or her income, so they get to
> invest $2400 in their Roth IRA. After the same 30 years at
> the same 5% this grows to the same $10,722.59.
>
> `Of course, if $3000 is invested in a Roth it will be more
> valuable after 30 years than $3000 invested in a
> Traditional, but this is not a fair comparison since the
> funds used to pay the current income tax on the $3000 are
> not being accounted for.
Actually, the situation still favors the traditional IRA,
but only by a small amount.
The reason for this is that withdrawals from a Roth IRA are
not completely tax-free, they are tax-free up to the
amount(s) contributed, and thereafter are included in
income.
Thus, in your example, at retirement, the Roth would have a
gross value of $10,722.59, the first $2,400 could be
withdrawn tax-free, and the remaining $8,322.59 would be
subject to tax at 20% (based on your assumption), leaving a
net after-tax value to the Roth of $9,058.07.
By comparison, the traditional IRA would have a gross value
of $13,403.23, and a net after-tax value of $10,722.59.
Thus, the traditional IRA provides $1,664.52 in additional
future benefit over the Roth IRA.
The Roth IRA really only provides a benefit over the
traditional IRA if you're in one of the lowest tax brackets
at contribution, and in the highest tax bracket at the time
you withdraw the amounts at retirement. Even so, the benefit
is not great.
For example, if you had an effective tax rate of 5% at
contribution, and an effective tax rate of 35% at retirement
when you withdrew the full amount, the Roth would only
provide you with an additional $561.89 in future benefits
over the traditional IRA.
In this case, unless the contributor's current effective tax
rate is 0%, the "right" answer is a traditional IRA if that
is an available investment.
However, even though a Roth is not as good as a traditional
IRA, it is definitely better than the alternative of a fully
taxable investment, unless you can be certain that you will
hold the taxable investment until retirement without ever
realizing any of the inherent gain.
For example, assume that you had a taxable investment on the
same assumptions as for the Roth, and the investment return
is taxed currently in each year.
In that case, the taxable investment will have a value of
$7,507.38 at retirement, none of which will be taxed on
withdrawal because it has all been taxed on a current basis.
The Roth therefore provides an additional $1,550.69 in
future benefit over the taxable investment.
Of course, if the taxable investment generates only
long-term capital gains, and those gains are realized less
frequently than every year, the taxable investment provides
better future benefits, and if held to maturity at 30 years,
provides a future benefit of $10,372.66, which is better
than the Roth, but not quite as good as the traditional IRA.
It would seem then, that generally speaking, absent unusual
circumstances, the traditional IRA is the "right" answer in
almost every case.
<< ======================================================= >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2006) - All rights reserved. >>
<< ======================================================= >>
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Posted by rlsusenet@NOSPAMPUHLEEZschnapp on April 13, 2007, 3:30 am
Please log in for more thread options Shyster1040 wrote:
> Actually, the situation still favors the traditional IRA,
> but only by a small amount.
>
> The reason for this is that withdrawals from a Roth IRA are
> not completely tax-free, they are tax-free up to the
> amount(s) contributed, and thereafter are included in
> income.
Huh? Really? That's completely counter to my understanding
of the Roth IRA! If that were the case, there'd be little
point to converting a conventional IRA to a Roth IRA.
My understanding was that qualified withdrawals from a Roth
IRA are completely tax free.
The Motley Fool website
(http://www.fool.com/money/allaboutiras/allaboutiras06.htm)
seems to agree with my understanding:
"Any qualified distribution from a Roth IRA is NOT included
in gross income for individual tax purposes. Simple as that.
In effect, a qualified distribution from a Roth IRA is
tax-free... no taxes due on the principal... no taxes due on
the earnings... no taxes due, period."
So, uh, who's right?
<< ------------------------------------------------------- >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2006) - All rights reserved. >>
<< ------------------------------------------------------- >>
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Posted by Victor Roberts on April 13, 2007, 3:30 am
Please log in for more thread options >> I've been thinking about the value of a traditional vs. Roth
>> IRA for my sons, who are just starting out. In the process
>> I came to the conclusion that one is not automatically
>> necessarily better than the other, even for young people. In
>> fact, given two simple assumptions, both types of IRAs give
>> EXACTLY the same results upon retirement. Under these
>> assumptions, the "tax-free accumulation" advantage of the
>> Roth is balanced by the tax-deductible feature of the
>> Traditional. So this is yet another decision where the
>> "right" answer is "it depends" and the facts necessary to
>> make the right decision do not exist, since they lie in the
>> future.
>>
>> Assumptions:
>>
>> 1) A fixed amount of pre-tax money to fund the IRAs. Say
>> $3000.
>>
>> 2) The same marginal tax rate now and when the person
>> retires. Say 20% for this discussion.
>>
>> If a Traditional IRA is opened with $3000 at 5% APR,
>> compounded monthly, it will grow to $13,403.23 after 30
>> years. After 20% income tax, the IRA will be worth
>> $10,722.59.
>>
>> If the same $3000 is used for a Roth, the taxpayer first has
>> to use $600 of the $3000 to pay the taxes on the $3000 that
>> is not being deducted from his or her income, so they get to
>> invest $2400 in their Roth IRA. After the same 30 years at
>> the same 5% this grows to the same $10,722.59.
>>
>> Of course, if $3000 is invested in a Roth it will be more
>> valuable after 30 years than $3000 invested in a
>> Traditional, but this is not a fair comparison since the
>> funds used to pay the current income tax on the $3000 are
>> not being accounted for.
> Actually, the situation still favors the traditional IRA,
> but only by a small amount.
>
> The reason for this is that withdrawals from a Roth IRA are
> not completely tax-free, they are tax-free up to the
> amount(s) contributed, and thereafter are included in
> income.
Are you sure about this? The IRS states that qualified
distributions of INCOME from a Roth IRA are tax free.
Qualified distributions include normal distributions after
the tax payer reaches 59 1/2 years of age.
--
Vic Roberts
Replace xxx with vdr in e-mail address.
<< ------------------------------------------------------- >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2006) - All rights reserved. >>
<< ------------------------------------------------------- >>
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