3 ms·

I think (and correct me if I'm wrong) the advantage of a Roth is that you're paying the tax on a much smaller amount at entry than you are at exit. For example:

I think (and correct me if I'm wrong) the advantage of a Roth is that you're paying the tax on a much smaller amount at entry than you are at exit. For example: - I deposit $4000 into my Roth IRA this year. - This was post-tax income on $6000. - In 40 years, It grows to $20000. - My total tax burden is still $2000.

mdasen 10y ago
You have to think about it in terms of what you get out. Let's say that you deposit $4,000. You've paid $2,000 in tax or 1/3rd of your money. That grows to $20,000 (5 * 4,000) which you can put into your pocket. Let's say that you deposit the entire $6,000 into a traditional IRA. That grows (at the same rate) to $30,000. You take that money out and owe the government 1/3rd of that money so $10,000 goes to the government and you pocket $20,000 - the same amount. So, with one exception, they come out the same assuming the same tax rate at both times. You're paying more tax to the government, but the amount in your pocket is the same. The one exception is that the cap is the same for both. So, if the cap is $5,500 and you put $5,500 into both, you'll get more out of the Roth. 5,500 * 5 = 27,500 in both cases, but in the case of the traditional, you'll still owe taxes. So, in effect, the Roth has a higher real contribution cap (even though the caps are nominally the same). Because the government didn't set the Roth contribution cap at 2/3rds of the traditional cap, you can effectively contribute more.
- jehanson 10y ago
  This is why any analysis of Roth vs Tradiational is inherently flawed. The maximum contribution amount for both Roth and Tradional accounts is $5,500. If you're condidering funding a Roth with $5,500, that means that you committing $8,209 of pretax income (if your marginal rate is 33%) to the cause. If you chose to go the Tradiational route with that $8,209, you'll put $5,500 in your Tradational account and have $2,709 of pretax earnings left over. Once you pay your 33% marginal tax on that, you'll have $1,815 left over to put into a taxable account. So the real question is Would I rather have: $5,500 in a Roth IRA or $5,500 in a traditional IRA AND $1,815 in a taxable account. At first glace the second option seems better, but this quickly evaporates when your time horizion is many decades in the future. The $1,815 you invested in the taxable account will see a slightly lower compound growth rate (as you have to liquidate a small fraction each year to pay the dividend/capital gains taxes that year). Even if the tax drag on your growth is just 40 basis points anually, that means over a 40 year horizon identically invested funds in the taxable account will be worth 15% less than in a tax-sheltered account. For any reasonablly long time horizon, the extra tax sheltering of the ROTH is more advantagous than the higher nominal balance in the tradional&taxable scenario.

mdasen 10y ago

You have to think about it in terms of what you get out. Let's say that you deposit $4,000. You've paid $2,000 in tax or 1/3rd of your money. That grows to $20,000 (5 * 4,000) which you can put into your pocket. Let's say that you deposit the entire $6,000 into a traditional IRA. That grows (at the same rate) to $30,000. You take that money out and owe the government 1/3rd of that money so $10,000 goes to the government and you pocket $20,000 - the same amount. So, with one exception, they come out the same assuming the same tax rate at both times. You're paying more tax to the government, but the amount in your pocket is the same. The one exception is that the cap is the same for both. So, if the cap is $5,500 and you put $5,500 into both, you'll get more out of the Roth. 5,500 * 5 = 27,500 in both cases, but in the case of the traditional, you'll still owe taxes. So, in effect, the Roth has a higher real contribution cap (even though the caps are nominally the same). Because the government didn't set the Roth contribution cap at 2/3rds of the traditional cap, you can effectively contribute more.

jehanson 10y ago
This is why any analysis of Roth vs Tradiational is inherently flawed. The maximum contribution amount for both Roth and Tradional accounts is $5,500. If you're condidering funding a Roth with $5,500, that means that you committing $8,209 of pretax income (if your marginal rate is 33%) to the cause. If you chose to go the Tradiational route with that $8,209, you'll put $5,500 in your Tradational account and have $2,709 of pretax earnings left over. Once you pay your 33% marginal tax on that, you'll have $1,815 left over to put into a taxable account. So the real question is Would I rather have: $5,500 in a Roth IRA or $5,500 in a traditional IRA AND $1,815 in a taxable account. At first glace the second option seems better, but this quickly evaporates when your time horizion is many decades in the future. The $1,815 you invested in the taxable account will see a slightly lower compound growth rate (as you have to liquidate a small fraction each year to pay the dividend/capital gains taxes that year). Even if the tax drag on your growth is just 40 basis points anually, that means over a 40 year horizon identically invested funds in the taxable account will be worth 15% less than in a tax-sheltered account. For any reasonablly long time horizon, the extra tax sheltering of the ROTH is more advantagous than the higher nominal balance in the tradional&taxable scenario.