Comments on: 5 Reasons why Everyone Needs a Traditional IRA

By: Settle Tax Debt

Settle Tax Debt — Thu, 15 Apr 2010 21:10:22 +0000

Roth IRAs are under-utilized. So many people focus on the tax deductibility of traditional IRAs that they fail to pick up on the tax advantages of Roths.

By: alperen

alperen — Mon, 07 Dec 2009 13:47:29 +0000

Thanks for the explanation.

By: Debt Cancellation

Debt Cancellation — Mon, 30 Nov 2009 20:11:40 +0000

I agree that everybody should have an IRA. The problem is that many folks just cannot afford to contribute. I agree that Roths can work well for some people, but you need to have the money to begin with.

By: Britt (Your Roth IRA)

Britt (Your Roth IRA) — Thu, 21 May 2009 17:38:21 +0000

With my personal finances, I find a Roth IRA to be a better.

Since the contribution limits are the same for both the Traditional IRA and the Roth IRA, if youâ€™re able to contribute to both, the tax deductibility of a Traditional IRA actually works against it.

Why?

Because when I go to withdraw my money from a Roth, I donâ€™t have to pay taxes. But with a Traditional IRA, I will have to pay taxes upon withdrawal.

So even though I laid out more cash initially to fully fund my Roth IRA, I end up with more in retirement because the funds in my account will be free and clear of taxes.

That said, once I pass the phase-out income limit for contributing to a Roth, a Traditional IRA will be preferable over a regular brokerage accountâ€¦

By: Jessie

Jessie — Thu, 30 Apr 2009 03:37:03 +0000

Ryan is right on! There is really almost no reason why a 20-something would want a Traditional over a ROTH. The big reason is that all 20-somethings will need to wait 30-something years before they are eligible to start taking out substantial sums of their retirement.
That means the money is going to have a LONG time to grow. For instance 20k invested for 33 years at 5% annual growth comes out to around 100k.

If that money were in a traditional IRA you would pay ordinary income tax on the full 100k!!! Ouch! Right now that would mean losing about $35,000 in taxes.

If you had put that 20k in a Roth… and paid the 4k in taxes now. Then the money grows to 100k. When you retire you get to take the full 100k whenever you want with no tax worries.

That’s a huge, huge, huge difference now.

And as for this quick last minute traditional IRA contribution to lower your tax bracket and save money… it’s basically crap.
Here’s a scenario to illustrate this point:

This article makes it sound like if you made 35k you would pay ($35,000 x 0.25 = $8,750) in taxes. Then they would have you think that if you pay 3k into your traditional IRA you would drop your income to 32k for the year, which puts you in the 15% tax bracket. So you would pay ($32,000 x 0.15 = $4,800) in taxes. So by contributing 3k to a traditional IRA you were able to lower your tax bracket and save ($8,750 – $4,800 = $3,950) in taxes. If this actually is how taxes were calculated it would be great and this would work…

But our taxes are calculated on a tiered system. If you make 35k a year you will pay in taxes:

$8,025 x 0.10 = $802.50 +

$24,525 x 0.15 = $3,678.75+

$2,450 x 0.25 = $612.50 = $5,093.75

If you put the 3k in your traditional IRA you now have a taxable income of 32k, right… and the total taxes on that are:

$8,025 x 0.10 = $802.50 +

$23,975 x 0.15 = $3,678.75 = $4,481.25.

So you can see how you have paid $3,000 into your IRA, but you only lowered your tax liability by $612.50

It is a tiered system. On the first $8,350 everyone pays 10% taxes, then on the next $25,600 everyone pays 15% taxes, and on the next $48,300 everyone pays 25% taxes.

By: alara

alara — Mon, 01 Dec 2008 18:02:13 +0000

It is true that capital gains are not taxed with a traditional IRA. Capital gains are not taxed until the capital gain is realizedâ€¦ that is, upon sale. BUT IRA distributions are taxed as ordinary incomeâ€¦. and the Roth will be tax free in that capacity, provided you follow all requirements.

By: Craig

Craig — Mon, 24 Nov 2008 20:24:40 +0000

Thanks for the explanation. I do not know much about the difference so this was a big help. It seems there are a lot of advantages to a traditional IRA. I’m sure there are advantages to the other types of retirement fund as well. Maybe a follow up article could have a basic pros/cons lists of each. I had a traditional IRA set up with a former job, and now with my new job I don’t have anything set up through the company. To be honest I kind have lost contact with anything involving that former IRA account and don’t know even where to begin to find out more about it and what to do next. Any advice?

Craig
http://www.budgetpulse.com

By: Rob W

Rob W — Mon, 24 Nov 2008 13:11:21 +0000

@ Ryan,

You have some very good and valid points. The idea I’m trying to convey is that if I’m already retired or not working by age 59 1/2 capital gains and income taxes will be much lower on a traditional.

By: G.E. Miller

G.E. Miller — Sun, 23 Nov 2008 00:48:08 +0000

@ Stephanie – sound strategy.

@ Rob, Ryan – This post was not a “why traditional IRA’s are superior to Roth IRA’s post”, nor was it meant to compare the benefits of each to the other. I think Roth IRA’s are great as well, and I have one. This post was to merely point out the benefits of a traditional IRA. There are certainly unique aspects to a traditional that can only be gained from having one, as I’ve listed. I could just as easily create a “5 Reasons why” post for Roth’s, and that may be coming down the road. Thanks for adding to the discussion.

By: Ryan

Ryan — Sat, 22 Nov 2008 22:18:59 +0000

Not sure agree with your conclusions, or the exclusivity of the benefits of a traditional IRA over that of the Roth IRA. Especially for those in their 20s. Generally, it seems safe to assume that younger people will be in a higher tax bracket upon retirement… thus the tax benefits now are often outweighed by receiving distributions at a higher taxable rate. Plus traditional IRAs also have tax risk involved. With an IRA, you know the rate you are taxed on contributions…. but in 40+ years when your withdraw your traditional IRA, the relevant tax rate could be different– either higher (ugh), or lower (great!).

It is true that capital gains are not taxed with a traditional IRA. Capital gains are not taxed until the capital gain is realized… that is, upon sale. BUT IRA distributions are taxed as ordinary income…. and the Roth will be tax free in that capacity, provided you follow all requirements.

You can roll directly into a Roth IRA… if you have a Roll 401(k). The only “penalty” is the applicable tax rate. Personal choice on whether or not to take that hit now or later.

The same flexibility, I believe, largely applies to Roth IRAs, in timing of contributions… though for tax upfront purposes, it is largely not relevant. With a Roth IRA, you can withdraw your contributions–not additional earning, though–at any time, without penalty.

So no, I wont’ be getting a traditional IRA until my income reaches a level that I no longer qualify for Roth IRA contributions, or that the later tax benefit is no longer worthwhile compared to the immediate benefit. I strongly recommend other 20 somethings consider this strategy as well. But each persons situation is different, so if in need of advise, do some reading through reputable (not a slight at this blog at all…. I read it often) sources or contact and advisor.