Re:Investing for Geeks
by jehanson on Friday September 16, 2016 @03:21PM
(#12516573)
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.
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.