Roth IRA

Andy_Bu

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Read the original post. The whole point of the thread was that he did not have enough money to fund both to the max.

As such the question boiled down to, if I only have $4K to invest, is it better to put $2K into two Roths or $4k into one Roth.

The answers you see after that are based on that question.

Andy
 

Andy_Bu

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Hi Brian,

As someone who is always trying to learn more about personal finance, I noticed that you said "mostly".

If you see anything that I stated that was wrong or even slightly misguided, please send me an email or IM to correct me (if you are alllowed to do that).

Thanks!

Andy
 

PhillJones

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I didn't just put in my own conditions, I ran a series of simulations. I tried to find a situation where a theoretical individual would benefit from the trad. option. I put John Doe in the 35% tax bracket before retirement and the 15% bracket after, had him contributing for a range of values from 5 to fifty years. I still could not get the trad. to come out better.

So I guess my confusion is who would benefit from a traditional IRA/401k vs the Roth? I can't seem to work out who the product would be suitable for. So either I'm missing something or have hit upon the biggest secret in personal finance and everybody with a traditional retirement plan is a sucker
. I suspect the former is true, rather than the latter.

I even tried to account for putting the difference in contribution levels into a savings account. I figured that the game is stacked in favour of the Roth since post tax dollars are worth more than pre-tax dollars. Even then the Roth outstripped the Trad by a large margin.
 

Andy_Bu

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I think this may be because the calculator can not accurrately model one of the biggest benefits of the traditional IRA over the Roth and that is for people who want to retire early(or for other reasons they might need the money early).

You are not allowed (with out penalty) to take any money out of a Roth until 59.5, where as you can do it much earlier under a traditional umbrella if you withdraw money in a series of “substantially equal period payments” based on your life expectancy.

Here is a nice table of the differences between the two

http://www.tiaa-cref.org/support/ira...l_vs_roth.html

As stated earlier, I believe most people who are allowed to choose between traditional and roth would be better off in a Roth but its not true for all cases.

I just wish I had the chance to use a Roth, which is why I can't wait for the Roth 401k to available to me someday.

Andy
 

Chris Lockwood

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> As a someone in the financial industry I am forbidden by my employer from putting in my two cents.

No problem, two cents is too small an IRA contribution to make anyway.


Interesting they impose that restriction, since we don't know who you are or who you work for- they really gag your freedom of speech, even if you post from your own computer on your own time? Wow.


> You are not allowed (with out penalty) to take any money out of a Roth until 59.5

Not true. There are exceptions, like taking the money out to buy your first home. And the big one: your original contributions to the Roth can be withdrawn at any time without penalty or tax (since you've already paid tax on that money when you earned it).
 

Andy_Bu

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Your statement is correct as listed in the link I provided. I should have mentioned the exceptions. Although the money you can take out for the house is limited to only 10k I think.

Andy
 

Todd Hochard

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Maybe here's what you're doing wrong-

I'd bet you're putting 4k into the accounts in either situation. Here's what's wrong with that- if you're in the 25% tax bracket, $4000 into a pre-tax account is actually only $3000 into an after-tax account. After all, they are the same amount of dollars out of your pocket. If you can afford to put $4000 of your net pay into an account, then you can afford to put $5000 of your gross into a pre-tax account. They are the "same" amount.

Think dollars out of your pocket at the time of deposit.

Otherwise, link up the calculator, and let someone else run it.

To me, Roth vs. Traditional boils down to-

1. Tax bracket now vs. where you expect to be in retirement.
2. The likelihood that tax rates will go up or down.

I've tended toward my 401k up to this point, but I have some decent funds to choose from. I'm about to start cutting that, and putting the difference into my Roths, to diversify. I was doing both a few years ago, but can't manage to swing both any longer.
 

DaveF

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Traditional vs Roth IRA: There is no difference in the returns, start and ending tax brackets being equal. In other words, choosing between Traditional and Roth IRA requires speculation on your unknown, future tax rates (and comparing them to your known, present tax rates).

This is a topic and conversation that fascinates me, and I've been interested in everyone's opinion here. It reminds me I need to adjust me retirement plans now that I'm married.

But in the midst of all tax laws, early retirement ages and online calculators, some fundamental math gets lost.

A = Amount in future
P = Principal amount
r = annual interest rate e.g. 0.05 = 5% / yr
t = time (in years)
T = tax rate

For continuously compounded interest, the future value of my investment is:
A = P*Exp(r*t)

If I have a traditional IRA and postpone the taxes until the future:
A = [ P*Exp(r*t) ] * (1 - T) = (1-T)*P*Exp(r*t)

If I use a Roth IRA and pay taxes now on my investment:
A = [P*(1-T)] * Exp(r*t) = (1-T)*P*Exp(r*t)

Same result. Period.

This holds true for the case of continued reinvestment--additional money invested each year. As PhilJones explained earlier, separate investments grow in value the same as an equivalent single investment. Each year is equivalent to its own investment and grows as just described; tax now or later, doesn't matter.

An example:
If I have exactly $1000 in hand to invest and my marginal tax rate is 25%, I can choose to invest $1000 right now in my Traditional IRA, earning 5% for 20 years. I end up with $2710. I'll then pay 25% taxes on it leaving me $2032.

Or I can take my $1000, pay my 25% taxes on it and invest the $750 at 5% for 20 years. And my investment will be worth $2032, with no further taxes to pay.

I agree with Todd Hochard: the issue of always applying the taxes is an important piece that's easily overlooked. If you have $1000 to invest now in a Roth (after taxes), that means you actually have $1333 to invest in a traditional IRA (assuming 25% tax).

Here's three websites with the math review
http://www.moneychimp.com/articles/f...ompounding.htm
http://cs.selu.edu/~rbyrd/math/continuous/
http://mathworld.wolfram.com/CompoundInterest.html

Hope this is helpful!
 

Philip Hamm

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There's a lot of people who don't qualify for a Roth.
 

Todd Hochard

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There are lots of people that make >$160k/year as married couples? Where are they working, and are they hiring?
 

Chris Huber

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Thanks for your alls posts. I did find the answer on my own from an online calculator. It's actually a little better to have 2 accounts and no max out, then to have 1 account and max it out...
 

Andy_Bu

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Just to be exact, that is a combined income(AGI), not each person making $160k.

Like John, both myself and my wife are engineers (she is part time at 30 hours), so it really only takes two good jobs before you quickly go over that limit.

Andy
 

Andy_Bu

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This makes no mathematical sense to me unless you are putting more in the two accounts than you are in one account.

If you invest $4000 in one account or spread $4000 in two accounts, your investment return is identical.

If you intend to invest $6000 (in two) instead of $4000(in one), then obviously the end number will be better but that is comparing apples to oranges a bit.

Andy
 

Todd Hochard

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I know. I was mostly kidding.

My wife stays home with our kids, but I'm not finding it that hard to afford Northern VA.
 

Eric_L

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The one thing being overlooked is account fees. Far too many firms now charge a fee for smaller accounts. I think that is the most foolish short-sighted thing they can do - but that is for a different thread.
Because of that it may make more sense to limit the number of accounts you hold when your balances are just starting out.

Also, regarding ROTH IRAs, assuming the tax bracket stays the same there is at best only questionable benefit for the investor - but the benefit to their survivors can become more considerable as the investor ages. I think this feature has been overlooked here.
 

PhillJones

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D'Oh!

....

Just in case my succinct reply is not obvious. I've just realized I've missed the obvious explanation for all this shenanigans. As DaveF's nice bit of maths proves, it don't matter if you scrape off a set percentage before or after you've earned the interest. The return is the same BUT, as I said and Todd explained, you actually invest more in the Roth because post Tax dollars are worth more than pre-Tax dollars.

I suppose the trad makes more sense if you're either taking the difference in your monthly income and investing it in some place with a decent return or you can't afford to max it out anyway. In those cases, this business about tax rate after retirement starts to make sense.

Thanks guys.
 

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