Dec 4

Imagine two people starting with 2,000 pre-tax dollars to invest at age twenty-five. The tax rate is a constant 25 %, and the capital gains rate is constantly 15 %.One person invests in the ROTH IRA (for 1,500 dollars because of the tax), and one invests in the Traditional IRA. If the annual rate of return for each investor is 8%, who does better in the end if retirement is age 70, exactly 45 years later?


3 comments so far...

  • bostonianinmo Said on December 4th, 2009 at 3:45 am:

    All income in a traditional IRA is taxed as ordinary income. Any capital gains within the IRA receive no special treatment.

    The traditional IRA will have more money in it at the end of 45 years because of the higher contributions but any withdrawals will be taxed as ordinary income. The withdrawals from the Roth will be tax free.

  • PepsiLime Said on December 4th, 2009 at 4:16 am:

    You’ve got 2 different questions. Capital gains don’t matter in a traditional IRA when you start making withdrawals, no matter what your age. It’s all taxed as ordinary income. As for who does better in the end between a regular IRA and a ROTH IRA, the person with the regular IRA will have more money at age 70, because they invested more each year ($2,000 for regular IRA, $1,500 for ROTH), but once they start taking withdrawals, the ROTH IRA distributions will be tax free, and the regular IRA distributions won’t be. So it’s hard to say who’ll make out in the end, but what they do say is that if you’re expecting to retire and be in a lower tax bracket a regular IRA is better, and if you’re expecting to retire and be in a higher tax bracket a ROTH is better.

  • ninasgramma Said on December 4th, 2009 at 4:39 am:

    There are no capital gains issues to deal with. You didn’t figure how the withdrawals are taken at age 70. That will affect which investment is better.

    In the scenario you describe, each investment results in equal accumulations after taxes if the entire balance is withdrawn at age 70.

    After 45 years, the traditional IRA balance will be $63,841. The Roth balance will be $47,881.

    If the entire balance is withdrawn at age 70, the person with the Roth will pay no taxes and have $47,881. The person with the traditional IRA will have to pay 25% taxes on the $63,841 and have the same $47,881 after-tax.

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