New investors should look at Roth Ira

[audreyh1]

It was moot for me. By the time Roth IRA was available I was making too much for either myself or DH to qualify.

I'm one who has a much higher total income in retirement yet my overall tax rate is lower because most of the income is in qualified divs and long-term cap gains. The ordinary income is much lower, and low enough to be well under the 0% cap gains tax threshold.

 

[pb4uski]

Same here. But once we start SS we'll be in a higher tax bracket but still lower than when the income was deferred so tax-deferred has been benefit to us.

 

[bingybear]

In my scenario we are working with $1,400. $1,000 goes into Roth and $1,000 into a tax-deferred IRA. The other $400 either gets paid in taxes or gets put into a fund for future taxes. If you put the same amount into both IRA's, it looks to me like you are ahead with the Roth.

Not really a fair comparison. That $400 should go into an investment account even if it is being saved for taxes someday. To be fair I would assume tax efficient investing.

 

[kaneohe]

Not really a fair comparison. That $400 should go into an investment account even if it is being saved for taxes someday. To be fair I would assume tax efficient investing.

bb..........I believe ss chose misleading words but actually meant an investment account w/ "same" nominal rate of return. ss accounted for LTCG on that taxable account but not the tax drag of dividend taxation over time but that doesn't change the conclusion......just the size of the delta.

My interpretation of what ss modeled:
Start w/ 1K and 0.4K
1)Roth.....put 1K in Roth and 0.4K to pay taxes. Net result 1K in Roth. Roth grows to 32K in N yrs. You have 32K after tax.
2)TIRA....put 1K in TIRA. Pay no taxes so have 0.4K in taxable side fund.
TIRA grows to 32K in N yrs. Side fund grows to 12.8K- at same growth rate as TIRA. Tax on TIRA is 12.8K. Side fund is 12.8K- which "roughly" balances the tax. However because of the - sign, the Roth is larger after tax.
The - represents 2 losses.......the tax drag of the taxable account over the years because distributions are taxed and the LTCG of the taxable account at final sale. The difference can be significant at higher tax rates/return rate
but can be 0 if in 15% bracket where QDIV/LTCG not taxed.

 

[pb4uski]

But... in the analysis you need to recognize that the income from the taxable side fund growth and income is subject to tax. So using sunsnow's $1,400 example, 50 years at 7% and 40% tax rate on front or back.

Roth.... $1,000 at inception grows to $29,457.

IRA.... $1,000 at inception grows to $29,457... $17,647 after 40% tax on withdrawal.
$400 taxable grows to $3,129 at after-tax return of 4.2% [7% * (1-40%)]
total after-tax proceeds are $20,596

Roth wins big time... but IRA is still much better than doing nothing and having $1,400 just sit in a taxable account... that only grows to $10,953. Preferenced rates on qualified dividends and LTCG would narrow the gap.

That said, 40% is probably a bit high but the conclusion would not differ is you used 25% or some lower rate. At a 25% tax rate the results would be $29,457, $26,206 and $18,081.

 

[nash031]

I've always had a Roth IRA. I got DW into a Roth IRA from traditional when we married. We will slowly make conversion from her traditional over time.

Roth TSP (403b) wasn't available when I started investing, and by the time it came open the benefit of keeping us in a lower tax bracket today outweighed the future tax benefits tomorrow, so we are both in traditional TSP/403(b) while still maxing our Roth IRAs.

I seriously doubt our income in retirement will push us into a higher tax bracket than we are currently in based on our current retirement plans. If we scrap those and work longer allowing our investments to continue to grow while contributing, then we might be in that situation. At that point, the tax hits won't matter quite as much since it'll be coming out of discretionary funding anyway. Our basic needs and desires will be covered, and we'll be in RobbieB territory of "blowing dough".

The answer here is YMMV, but I agree with OP that young investors need to really take a hard look at Roth accounts, and for a lot of people they're going to be the best option. I just wouldn't make definitive statements for "all" or "most" as OP seemed to.

 

[kaneohe]

But... in the analysis you need to recognize that the income from the taxable side fund growth and income is subject to tax. So using sunsnow's $1,400 example, 50 years at 7% and 40% tax rate on front or back.

Roth.... $1,000 at inception grows to $29,457.

IRA.... $1,000 at inception grows to $29,457... $17,647 after 40% tax on withdrawal.
$400 taxable grows to $3,129 at after-tax return of 4.2% [7% * (1-40%)]
total after-tax proceeds are $20,596

Roth wins big time... but IRA is still much better than doing nothing and having $1,400 just sit in a taxable account... that only grows to $10,953. Preferenced rates on qualified dividends and LTCG would narrow the gap.

That said, 40% is probably a bit high but the conclusion would not differ is you used 25% or some lower rate. At a 25% tax rate the results would be $29,457, $26,206 and $18,081.

Wonder what you would get if you used different numbers for taxable. If return is 7% of which 2% is dividends taxed at 15%, you lose 0.3% of return. The net dividend return is 1.7%. Assume no CG distributions so CG return is 5% for a total current AT return of 6.7%. Compound that for 50 yrs and then take the 15% CG tax at the end. Should increase taxable acct return a bit.

 

[pb4uski]

That is pretty doable.

([$400 *(1+(7%-(2%*15%)))^50]-$400)*(1-15%) = $8,763; fails to include reinvested dividends in the basis of the terminal gains tax calcuation but probably pretty close.

Replacing $8,763 for $3,129 changes IRA total to $26,410 and the taxable amount to $21,907... compared to $29,457 for the Roth.

 

[kaneohe]

That is pretty doable.

([$400 *(1+(7%-(2%*15%)))^50]-$400)*(1-15%) = $8,763; fails to include reinvested dividends in the basis of the terminal gains tax calcuation but probably pretty close.

Replacing $8,763 for $3,129 changes IRA total to $26,410 and the taxable amount to $21,907... compared to $29,457 for the Roth.

Wow! that was fast......good pt about reinvested div and basis....forgot about that. Looks like gaps are narrowed quite a bit but still same relative ranking. Thanks.