4 ms·

Not just anything, but the other kind of IRA lets you put money in without paying income tax first.

• colordrops 5y ago
  Why are you ignoring the most significant difference with the other kind of IRA?
  • sp332 5y ago
    That with a Roth IRA you pay the tax rate when you're working, and a normal one you pay according to the tax rate when you're retired?
    • colordrops 5y ago
      Once again you are leaving out an important detail. The amount of money that you pay the tax on for a Roth is often orders of magnitude less than a traditional IRA, regardless of rate. You are avoiding A LOT more tax with a Roth. It's a fixed initial payment with a Roth, yet it scales indefinitely with a traditional IRA. It's a huge difference.
      • sp332 5y ago
        I was never clear on how much difference it made. Either you pay (say) 20% up front or you pay 20% later. With compound growth multiplying in the middle, does it really make a difference to how much you have at the end? 0.8 * (1.07 ^ 20) == (1.07 ^ 20) * 0.8
        • colordrops 5y ago
          Your math is wrong. (0.8 * 1.07) ^ 20 and (1.07 ^ 20) * 0.8, which are not equal. I'm assuming that 0.8 is the percentage after tax, 1.07 is the deposit, and 20 is the growth.
          • lmm 5y ago
            No, your mathematics is wrong. The growth rate (1.07) is what's compounded, not the deposit.
            • colordrops 5y ago
              No, my assumptions are wrong then - what does "20" represent here? and does the "^" symbol represent the power function?
              • sp332 5y ago
                Yeah sorry for being cryptic. It's 20 years compounding at 7% per year. Scenario one: take your starting investment, subtract 20% for taxes, then do the compound growth. Scenario two: take your whole starting investment, do the compound growth, then subtract 20% of the result. It's totally possible that I missed modeling some part of the situation that somehow makes more money from the Roth way of doing things. But the models above produce the same results.
            • matthewdgreen 5y ago
              Imagine I’m Peter Thiel and I have obtained 1 million shares of PayPal at $.01 each. After 20 years I’m going to be able to sell these at $1000 each (all numbers made up). Thiel can now do one of two things: 1. Roth IRA: Pay taxes on the value of the principal up front, but not pay taxes on appreciation. Let’s say a 20% tax rate (made up for simplicity), so 20% x .01 x 1M = $2,000. Thiel writes a check for this relatively small number. 2. Traditional IRA: pay no (immediate) taxes on the principal up front, but pay taxes on the appreciated value. So assuming the same tax rate: 20% x 1M x $1000 = $200M. Your math is correct, of course. The mistake is assuming that Theil would pay taxes by selling 20% of his inordinately valuable $.01 PayPal shares, even though technically (after appreciation) those would be worth $200M. That would be stupid —- obviously he wouldn’t do that, he would just write a check from his bank account — selling that principal would be absurd since such shares can’t be purchased or sold on any liquid market. The entire purpose of using a Roth IRA here was that Theil had access to a unique, non-liquid asset with a potential for extremely high appreciation, and he wanted to insure himself against paying taxes in the likely event that happened. IMHO a part of the problem here is that the initial “price” of PayPal wasn’t determined by the market. So allowing Theil to pay taxes at that rate made it absurd for Theil to sell any of his principal to pay taxes. Even if you grant that PayPal was basically a lottery ticket, we shouldn’t use a middle class tax vehicle to shield taxes on assets that the middle class (broadly) doesn’t have access to in public markets.