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Which is really better? Roth or Traditional

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mlathe
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Which is really better? Roth or Traditional  Reply with quote  

So everyone says that Roth IRAs are so much better than Traditional IRAs but when i look at the math they don't look that much different.

This tax year the max IRA contribution is $4000. So here are two scenarios:

1) invest $4000 into a Roth. But really i'm investing $4000+taxes, so $4000+30%($4000)=$5200. Note any earnings that i make in the long run are tax free, but there is a $1200 front end load just for this privilege.

2) invest $4000 into a Traditional IRA. You need to pay taxes later... but when you are older you will probably be living on less money, hence, less taxes. Since this is pre tax you should invest (not spend!) the tax savings ($4000*30%=$1200) into something else.

As you can see in both cases we "invest" $5200. In 1) we have a $1200 front end load, in 2) we have a 30% back end load. Which is better? Can you give numbers to illustrate the solution?

--Matthias
Post Fri Aug 26, 2005 2:34 am
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MattL
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I can't come up with numbers right now, but the biggest factor is what your tax rate wil be during retirement vs. now. If you could see into the future you would know for sure, the best thing you can do now is estimate what it will be during retirement based on the amount of income you plan on withdrawing and a guesstimate of the tax situation at that time.

Debt Elimination
Post Fri Aug 26, 2005 4:21 pm
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mlathe
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true... if in the future everyone (companys and people) pay a flat tax (I think it would be less than 20%) then a traditional would be better. But if we become more socialist in our taxes and end up paying %50+ then a Roth would be better. This will always be a gamble.

So lets just assume that the taxes are the same for me right now as it will be in 2045.

Which is better and why?
--Matthias
Post Sat Aug 27, 2005 2:03 am
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mlathe
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any one else want to try?
Post Mon Aug 29, 2005 2:52 am
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bong12187
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quote:
Originally posted by mlathe
any one else want to try?


I have the number. Lets say a 25 years old individual decided to put in 4k every year up to age 59 for a traditional IRA. at age 60, he will have $110,410.00. If he decides to withdraw it all, he will get hit with $33,723. Leaving him $78,687.00.

With your scenario of putting in 4k per year and being taxed $1,200.00 on the front end to be able to put in the 4k, and lets say everything the same constant like what I mentioned in the first paragraph, the individual will have $110,410.00 by age 60. However, since he got hit with $1,200.00 from age 25-59 years old, his total front end tax came up to $42,000.00. This leaves him $70,410.00 which is really his actual return.

The scenario that you provided left alot of things to consider. There is really no right answer due to people have different lifestyle and income. However, the numers I gave is correct only to the particular scenario you provided.

For me, I am currently maxing ROTH. This is because I am also maxing TSP (it is like a 401k without matching contribution for military). If I didn't have TSP, i'd be doing Traditional IRA. This is what I would do because at this point of time, tax savings is more important for me than not being taxed when I take it out at age 60.
Post Mon Aug 29, 2005 3:28 am
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pandashark
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Generally, the advice also depends on your age right? If you are close to retirement, then Traditional is the way to go, because there aren't that many years for income to accrue anyway. But for a younger person, in say their 20s or so, there's a lot of income that could potentially accrue before retirement, so in that case, you would want to avoid taxes down the road.
Post Mon Aug 29, 2005 5:01 pm
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Rolo
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Universal answer: "It depends".

Context is important.

Senator Roth made his IRA to alleviate fears of tying up money to encourage people, particularly younger people, to start investing for retirement. A Roth is much better than saving your emergency cash in a savings account for a few years before opening a Traditional IRA and then never getting to it because you keep tapping into the Übereasy savings account. A young couple in New Orleans probably won't appreciate a Traditional IRA about now.

Comments on your scenario:

You pay 30% in taxes? You should look into trimming that down.

Retirement accounts wouldn't be withdrawn all at once. (Well, unless you've just been told you have six months to live...then I would withdraw it all, heh)

Personally, I plan on consuming more cash at retirement rather than less. I want a much higher standard of living. Delayed gratification + Due dilligence = hedonistic excess ... is my formula. Very Happy

"Expect me when you see me."
Post Wed Aug 31, 2005 12:20 am
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mlathe
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bong12187... thanks... but you missed some of the subtleties of the math. You said a T-IRA would have $110,410.00 but pay $33,723 in taxes. Then you said a ROTH, would have $110,410.00-$42,000. But this isn't true... b/c with the ROTH you don't get to use your taxes to build your wealth. In other words the total for the ROTH would be much less than 110k, but whatever the value, you get to keep it all!

pandashark, I'm not sure if this is true. Age might not have anything to do with this. However age is VERY important if you are planning on rolling over your T-IRA into an ROTH.

Rolo thanks for the info... I think that you can get some money out of an IRA if you have an emergency... (i'm not sure if getting screwed counts though). Another thing... in my scenario, you can't compare the value of the IRA's if you don't cash them both...

quote:
Originally posted by Rolo
You pay 30% in taxes? You should look into trimming that down.


i just checked my last income tax. it looks like i AGI/total income tax (i got money back!)=9.28%. That seems REALLY low.
Post Wed Aug 31, 2005 2:23 am
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mlathe
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Here is a spreadsheet that i made that prompted this question.

Col C is just a running sum.
Col D looks like this: D24==(D23+(2000*0.65))*1.08... meaning, take the previous years total, add to it this years ROTH addition (2k-35% taxes) and grow it by 8%.
Col E looks like this: E24=(E23+2000)*1.08... meaning take the previous years total, and add 2000 and grow it by 8%.
Col F is what the T-IRA would look like if you cashed it all out this year... e.g. F24=E24-0.65.

Now note that D and F (the real numbers that count, since these are really the amount of money that you have access to) are always the same.

So where is the mathematical mistake here?

code:
  A       B                C               D              E              F
age    monthly          total      After tax     before tax     before tax
       addition    investment  IRA (Roth IRA)          IRA      IRA (with tax taken out)
23        $0.00         $0.00          $0.00          $0.00          $0.00
24    $2,000.00     $2,000.00      $1,404.00      $2,160.00      $1,404.00
25    $2,000.00     $4,000.00      $2,920.32      $4,492.80      $2,920.32
26    $2,000.00     $6,000.00      $4,557.95      $7,012.22      $4,557.95
27    $2,000.00     $8,000.00      $6,326.58      $9,733.20      $6,326.58
28    $2,000.00    $10,000.00      $8,236.71     $12,671.86      $8,236.71
29    $2,000.00    $12,000.00     $10,299.64     $15,845.61     $10,299.64
30    $2,000.00    $14,000.00     $12,527.62     $19,273.26     $12,527.62
31    $2,000.00    $16,000.00     $14,933.83     $22,975.12     $14,933.83
32    $2,000.00    $18,000.00     $17,532.53     $26,973.12     $17,532.53
33    $2,000.00    $20,000.00     $20,339.13     $31,290.97     $20,339.13
34    $2,000.00    $22,000.00     $23,370.26     $35,954.25     $23,370.26
35    $2,000.00    $24,000.00     $26,643.89     $40,990.59     $26,643.89
36    $2,000.00    $26,000.00     $30,179.40     $46,429.84     $30,179.40
37    $2,000.00    $28,000.00     $33,997.75     $52,304.23     $33,997.75
38    $2,000.00    $30,000.00     $38,121.57     $58,648.57     $38,121.57
39    $2,000.00    $32,000.00     $42,575.29     $65,500.45     $42,575.29
40    $2,000.00    $34,000.00     $47,385.32     $72,900.49     $47,385.32
41    $2,000.00    $36,000.00     $52,580.14     $80,892.53     $52,580.14
42    $2,000.00    $38,000.00     $58,190.55     $89,523.93     $58,190.55
43    $2,000.00    $40,000.00     $64,249.80     $98,845.84     $64,249.80
44    $2,000.00    $42,000.00     $70,793.78    $108,913.51     $70,793.78
45    $2,000.00    $44,000.00     $77,861.28    $119,786.59     $77,861.28
46    $2,000.00    $46,000.00     $85,494.19    $131,529.52     $85,494.19
47    $2,000.00    $48,000.00     $93,737.72    $144,211.88     $93,737.72
48    $2,000.00    $50,000.00    $102,640.74    $157,908.83    $102,640.74
49    $2,000.00    $52,000.00    $112,256.00    $172,701.54    $112,256.00
50    $2,000.00    $54,000.00    $122,640.48    $188,677.66    $122,640.48
51    $2,000.00    $56,000.00    $133,855.72    $205,931.87    $133,855.72
52    $2,000.00    $58,000.00    $145,968.17    $224,566.42    $145,968.17
53    $2,000.00    $60,000.00    $159,049.63    $244,691.74    $159,049.63
54    $2,000.00    $62,000.00    $173,177.60    $266,427.07    $173,177.60
55    $2,000.00    $64,000.00    $188,435.81    $289,901.24    $188,435.81


Post Wed Aug 31, 2005 2:51 am
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Rolo
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quote:
Originally posted by mlathe
i just checked my last income tax. it looks like i AGI/total income tax (i got money back!)=9.28%. That seems REALLY low.


Sounds right...mine is six-point-something as calculated by TurboTax (dunno if it is total income/tax or AGI/tax).

Don't forget about Socialism taxes: 6.2% for Soc. Sec. and 1.45% for Medicawelfare.

As far as tax-advantaged IRA vs. non-, I essentially do both: 403(b) and Roth. I just don't like all the rules of the Traditional and I plan to retire by 55 worst-case, so that 59-1/2 (WHAT is with the 1/2!?) is a bit late for me.

"Expect me when you see me."
Post Wed Aug 31, 2005 2:53 am
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mlathe
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Yeah i'm in the private sector so i'm doing a 401k. last year i did a Traditional IRA, but this year my AGI will be above the Max for IRA (i think i will get a partial deduction)... but who cares... Traditionals are only good if you get all of the deduction... so i'm doing a ROTH.

What is with that 1/2? leave it to the government.
Post Thu Sep 01, 2005 2:40 am
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bong12187
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quote:
Originally posted by mlathe
Here is a spreadsheet that i made that prompted this question.

Col C is just a running sum.
Col D looks like this: D24==(D23+(2000*0.65))*1.08... meaning, take the previous years total, add to it this years ROTH addition (2k-35% taxes) and grow it by 8%.
Col E looks like this: E24=(E23+2000)*1.08... meaning take the previous years total, and add 2000 and grow it by 8%.
Col F is what the T-IRA would look like if you cashed it all out this year... e.g. F24=E24-0.65.

Now note that D and F (the real numbers that count, since these are really the amount of money that you have access to) are always the same.

So where is the mathematical mistake here?

code:
  A       B                C               D              E              F
age    monthly          total      After tax     before tax     before tax
       addition    investment  IRA (Roth IRA)          IRA      IRA (with tax taken out)
23        $0.00         $0.00          $0.00          $0.00          $0.00
24    $2,000.00     $2,000.00      $1,404.00      $2,160.00      $1,404.00
25    $2,000.00     $4,000.00      $2,920.32      $4,492.80      $2,920.32
26    $2,000.00     $6,000.00      $4,557.95      $7,012.22      $4,557.95
27    $2,000.00     $8,000.00      $6,326.58      $9,733.20      $6,326.58
28    $2,000.00    $10,000.00      $8,236.71     $12,671.86      $8,236.71
29    $2,000.00    $12,000.00     $10,299.64     $15,845.61     $10,299.64
30    $2,000.00    $14,000.00     $12,527.62     $19,273.26     $12,527.62
31    $2,000.00    $16,000.00     $14,933.83     $22,975.12     $14,933.83
32    $2,000.00    $18,000.00     $17,532.53     $26,973.12     $17,532.53
33    $2,000.00    $20,000.00     $20,339.13     $31,290.97     $20,339.13
34    $2,000.00    $22,000.00     $23,370.26     $35,954.25     $23,370.26
35    $2,000.00    $24,000.00     $26,643.89     $40,990.59     $26,643.89
36    $2,000.00    $26,000.00     $30,179.40     $46,429.84     $30,179.40
37    $2,000.00    $28,000.00     $33,997.75     $52,304.23     $33,997.75
38    $2,000.00    $30,000.00     $38,121.57     $58,648.57     $38,121.57
39    $2,000.00    $32,000.00     $42,575.29     $65,500.45     $42,575.29
40    $2,000.00    $34,000.00     $47,385.32     $72,900.49     $47,385.32
41    $2,000.00    $36,000.00     $52,580.14     $80,892.53     $52,580.14
42    $2,000.00    $38,000.00     $58,190.55     $89,523.93     $58,190.55
43    $2,000.00    $40,000.00     $64,249.80     $98,845.84     $64,249.80
44    $2,000.00    $42,000.00     $70,793.78    $108,913.51     $70,793.78
45    $2,000.00    $44,000.00     $77,861.28    $119,786.59     $77,861.28
46    $2,000.00    $46,000.00     $85,494.19    $131,529.52     $85,494.19
47    $2,000.00    $48,000.00     $93,737.72    $144,211.88     $93,737.72
48    $2,000.00    $50,000.00    $102,640.74    $157,908.83    $102,640.74
49    $2,000.00    $52,000.00    $112,256.00    $172,701.54    $112,256.00
50    $2,000.00    $54,000.00    $122,640.48    $188,677.66    $122,640.48
51    $2,000.00    $56,000.00    $133,855.72    $205,931.87    $133,855.72
52    $2,000.00    $58,000.00    $145,968.17    $224,566.42    $145,968.17
53    $2,000.00    $60,000.00    $159,049.63    $244,691.74    $159,049.63
54    $2,000.00    $62,000.00    $173,177.60    $266,427.07    $173,177.60
55    $2,000.00    $64,000.00    $188,435.81    $289,901.24    $188,435.81





Hmmm... Mine is coming out different from yours. You said in the beginning that you already got taxed before maxing ROTH. So by putting in 2k, 30% tax bracket, it means that you already been taxed 600. This should be constant every year. This is also what cost you for putting in 2k to ROTH.
Hence, if you are putting in 2k per year regardless whether it is ROTH or Traditional IRA, and they are both receiving 8% return per year, the amount of total return should be the same as well. The only difference is that Traditional IRA will have to pay tax at the end of the tunnel. If both were taken out completely at the retirement date, ROTH IRA should have more than the Traditional IRA since money invested was made with PRETAXED dollars (600 monthly).
What you are doing is that you are taking out the tax prior to putting in the ROTH IRA. This is then giving you less than 2k to be invested. However, this is not what you said with your first post. Your first post said that 4k contribution but you already got hit with 1200 tax (30%) before you even made a 4k contribution. So it is actually costing you 1200 per year to max out a 4k ROTH contribution. I just divided 1200 since you cut your investment to 2k.
You are right about my first attempt to solve the problem. I was off tracked.

30% tax bracket
600 tax paid
2000 yearly investment

ROTH Yearly investment total investment Prepaid tax before maxing ROTH 8% return ROTH & Traditional IRA total yearly
25 $2,000.00 $2,000.00 $600.00 $160.00 $2,160.00
26 $2,000.00 $4,000.00 $600.00 $332.80 $4,492.80
27 $2,000.00 $6,000.00 $600.00 $519.42 $7,012.22
28 $2,000.00 $8,000.00 $600.00 $720.98 $9,733.20
29 $2,000.00 $10,000.00 $600.00 $938.66 $12,671.86
30 $2,000.00 $12,000.00 $600.00 $1,173.75 $15,845.61
31 $2,000.00 $14,000.00 $600.00 $1,427.65 $19,273.26
32 $2,000.00 $16,000.00 $600.00 $1,701.86 $22,975.12
33 $2,000.00 $18,000.00 $600.00 $1,998.01 $26,973.12
34 $2,000.00 $20,000.00 $600.00 $2,317.85 $31,290.97
35 $2,000.00 $22,000.00 $600.00 $2,663.28 $35,954.25
36 $2,000.00 $24,000.00 $600.00 $3,036.34 $40,990.59
37 $2,000.00 $26,000.00 $600.00 $3,439.25 $46,429.84
38 $2,000.00 $28,000.00 $600.00 $3,874.39 $52,304.23
39 $2,000.00 $30,000.00 $600.00 $4,344.34 $58,648.57
40 $2,000.00 $32,000.00 $600.00 $4,851.89 $65,500.45
41 $2,000.00 $34,000.00 $600.00 $5,400.04 $72,900.49
42 $2,000.00 $36,000.00 $600.00 $5,992.04 $80,892.53
43 $2,000.00 $38,000.00 $600.00 $6,631.40 $89,523.93
44 $2,000.00 $40,000.00 $600.00 $7,321.91 $98,845.84
45 $2,000.00 $42,000.00 $600.00 $8,067.67 $108,913.51
46 $2,000.00 $44,000.00 $600.00 $8,873.08 $119,786.59
47 $2,000.00 $46,000.00 $600.00 $9,742.93 $131,529.52
48 $2,000.00 $48,000.00 $600.00 $10,682.36 $144,211.88
49 $2,000.00 $50,000.00 $600.00 $11,696.95 $157,908.83
50 $2,000.00 $52,000.00 $600.00 $12,792.71 $172,701.54
51 $2,000.00 $54,000.00 $600.00 $13,976.12 $188,677.66
52 $2,000.00 $56,000.00 $600.00 $15,254.21 $205,931.87
53 $2,000.00 $58,000.00 $600.00 $16,634.55 $224,566.42
54 $2,000.00 $60,000.00 $600.00 $18,125.31 $244,691.74
55 $2,000.00 $62,000.00 $600.00 $19,735.34 $266,427.07
56 $2,000.00 $64,000.00 $600.00 $21,474.17 $289,901.24
57 $2,000.00 $66,000.00 $600.00 $23,352.10 $315,253.34
58 $2,000.00 $68,000.00 $600.00 $25,380.27 $342,633.61
59 $2,000.00 $70,000.00 $600.00 $27,570.69 $372,204.30
60 $2,000.00 $72,000.00 $600.00 $29,936.34 $404,140.64
$21,600.00

Total return minus tax taken out before maxing out ROTH $382,540.64
Total return for Traditional IRA minus 30% tax bracket $282,898.45
Post Thu Sep 01, 2005 3:07 am
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BlankenshipFP
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The reason your calculations in D and F are always the same is because you have not made the assumption of reduced (or increased, depending on your camp) tax rates when you pull out the funds. If you adjust your column F to show a 15% rate of tax on distribution, you'll see a dramatic difference - this is assuming that you'll have a lower tax rate when you distribute. Then you could adjust column F to show a 40% rate, if you want to see what would happen if the tax rates went up.

Hope this helps -

Jim Blankenship, CFP®, EA
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www.BlankenshipFinancial.com
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Post Thu Sep 01, 2005 11:37 am
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bong12187
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quote:
Originally posted by BlankenshipFP
The reason your calculations in D and F are always the same is because you have not made the assumption of reduced (or increased, depending on your camp) tax rates when you pull out the funds. If you adjust your column F to show a 15% rate of tax on distribution, you'll see a dramatic difference - this is assuming that you'll have a lower tax rate when you distribute. Then you could adjust column F to show a 40% rate, if you want to see what would happen if the tax rates went up.

Hope this helps -


It does and it would be the way I would have done it. However, if you look at the very first post that started this, the assumption is that when an individual puts in 4k (2k) in ROTH, he or she was already taxed from his/her earned income. The example given is that the individual is already got hit with 1200 (600) for every 4k (2k) he puts in at ROTH. Hence since it is pretaxed every time they contribute 4k(2k), column d will always be constant.
As far as column f is concern, again with the same scenario provided with the first post, contribution for both ROTH and Traditional IRA will be the same. Both will be contributing the same amount. What i didn't factor in is that how the contribution to Traditional IRA will help him in taxes. The parameter was not explained in the first post. Different people will have different tax rate. Hence, with 8% return, they will both get the same amount at the retirement date. The only difference now will be is that ROTH will not be taxed and Traditional IRA will.
Post Fri Sep 02, 2005 1:11 am
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efflandt
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What you really need to look at or crank into a spreadsheet is $1200 tax now and $4000 growing untaxed vs. non-taxable $4000 growth taxed at distribution + $1200 invested in taxable account. Also figure that a Roth IRA can be left to grow indefinitely (periodic payments not required) or can be drawn out in a lump sum as required or desired (when qualified), without taking any tax hit at that time.

So for an investment of $5200/yr, the contribution would be $4000 in either case, which in the Roth would grow untaxed. The non-taxed traditional IRA would be taxed on withdrawl (not on contributions), but would also have a column for taxable growth of the $1200 tax savings. Although, a majority of people would likely spend the tax savings instead of investing it.

People often throw about the 15% marginal tax rate at retirement, but unless you are retiring in the near future, you may need more than your current income (inflation), which even figuring social security might put you in the same bracket you are in now (especially if still covering mortgage or rent).

If you invest long in stocks or other investments considered long term gain, in a tax deferred IRA it would be taxed at your normal tax rate at withdrawl (possibly 25% or more), in a taxable account may be taxed at 15%, or in a Roth would be untaxed. So I am currently max'ing out my 401k for regular retirement income, and building a Roth and gradually converting my traditional IRA to Roth for flexible lump sum withdrawl for fun money or emergencies. I figure better to pay 28% for every $1000 now (including state tax) rather than 28% or more of $3000 or $5000 or whatever it grows to.

But future tax rates are unknown, and if the goverment ever switches from an income tax to a VAT on everything, then the tax paid on Roth contributions will be wasted, from a personal investment standpoint.
Post Fri Sep 02, 2005 4:20 am
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