[NA] Educate me on IRAs

CJones

CJones

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I was poking around on our company's retirement planning site and started reading up a little on IRAs. From what little I understand about it right now, it appears as though I could use a Roth IRA as a type of savings account - make taxed contributions to the account and make withdrawals from the 'contribution amount' tax-free later. So hypothetically, this could be a higher return (based on market fluctuations) version of a standard bank savings account.

Obviously, before I actually signed up for something like this, I would talk with someone about my specific numbers, but am I missing something in the fine-print that crushes my current logic?
 
One item about a "Roth" IRA (or 401(k)) is that you need to have the account open for at least 5 years before you can withdraw the principle tax free.
 
JeffDG said:
One item about a "Roth" IRA (or 401(k)) is that you need to have the account open for at least 5 years before you can withdraw the principle tax free.
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No the principle, the growth. The best reason for a Roth IRA is to lower your tax bracket, thus lowering your overall rate.
 
steingar said:
No the principle, the growth. The best reason for a Roth IRA is to lower your tax bracket, thus lowering your overall rate.
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Roth IRA do not lower your present tax bracket only later when you withdraw.

For example if you earn $101 and the $1 is in the 30% bracket you only net $.70

In a traditional IRA you would contribute that $1 to the 401k and pay no taxes on it until you withdraw it many years from now. Then you pay on the principal and interest. But perhaps at the time of withdrawal you only are earning $99 because you are no longer working. So the $1 you pull out of the 401k is not taxed at 30% but at the lower bracket of 25% and you net $.75.

For the Roth IRA you would pay the tax now and contribute the $.70 that is left over. Then when you withdraw you would only pay tax on the capital gain, not the principal, depending on age and a few other things.

You are hedging your bet that taxes are as low as they will be before you retire.

YMMV but if you are not at least putting the minimum in your pretax 401k to obtain your company match you should do that before any other sort of IRA including ROTH!

FWIW not everyone can utilize a Roth IRA. Check the rules, you may be earning too much money to be able to even participate.
 
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ScottM said:
For the Roth IRA you would pay the tax now and contribute the $.70 that is left over. Then when you withdraw you would only pay tax on the capital gain, not the principal.
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In a ROTH IRA both the principal and earnings are tax free, not just the principal
 
momalley said:
In a ROTH IRA both the principal and earnings are tax free, not just the principal
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My bad I added the depends on the wrong sentence. But you are not entirely correct in saying that the earning is tax free.

The answer is not a straight yes nor no, for the for the earnings it depends. Mostly it depends on the withdrawer's age. The principal is alway tax free withdraw.
 
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One other situation where Roth kicks the heck out of traditional is employer matching.

So, my company matches $0.50 per dollar up to 6% of my income. So I put 6% into my Roth 401(k) and pay the taxes on it. When I take it out in 20-30 years, that 6% has grown by a factor of 10, so I put in $1,000, and take out $10,000, tax free.

When you don't have the matching, there is an argument that instead of putting in $1,000, I could have put in $1,300, gotten a $300 tax break and been even, but that doesn't work for stuff like a company matching program.

(BTW, the $0.50 is put in "traditional" and they don't let me decide that...so for every $1.00 I put in Roth, another $0.50 goes in traditional as well)
 
ScottM said:
Well you missed the comma item. The answer is not a straight yes nor no. It depends for the earnings. Mostly it depends on the withdrawer's age. The principal is alway tax free withdraw.
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Did they take out the 5 year rule?

As I understood it (and I've not the energy to look it up right now), a Roth IRA account had to be open for at least 5 years in order to withdraw the principal from it tax free. Once that 5 year initial wait was up, you could withdraw the principal tax free regardless of when it went in (so if you put in $1,000 per year, at 5 years + 1 day, you could withdraw $5,000 and leave the interest/growth behind tax free).
 
ScottM said:
My bad I added the depends on the wrong sentence.

The answer is not a straight yes nor no, for the for the earnings it depends. Mostly it depends on the withdrawer's age. The principal is alway tax free withdraw.
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Correct, qualified withdrawals are entirely tax free
 
JeffDG said:
Did they take out the 5 year rule?

As I understood it (and I've not the energy to look it up right now), a Roth IRA account had to be open for at least 5 years in order to withdraw the principal from it tax free. Once that 5 year initial wait was up, you could withdraw the principal tax free regardless of when it went in (so if you put in $1,000 per year, at 5 years + 1 day, you could withdraw $5,000 and leave the interest/growth behind tax free).
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The 5yr rule is still in effect
 
JeffDG said:
Did they take out the 5 year rule?

As I understood it (and I've not the energy to look it up right now), a Roth IRA account had to be open for at least 5 years in order to withdraw the principal from it tax free. Once that 5 year initial wait was up, you could withdraw the principal tax free regardless of when it went in (so if you put in $1,000 per year, at 5 years + 1 day, you could withdraw $5,000 and leave the interest/growth behind tax free).
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Not sure. I blew past the income limit years ago so a Roth is not really an option for me. I considered converting when I moved jobs and was doing a roll over a few years ago. But decided to keep it in a traditional IRA. Withdrawal is not an option I ever plan to use. It would have to be something very catastrophic to even consider it. But I also keep a after take invest fund that is well stocked and the 401k maxed out. I also take the extra limit deductions because I accidentally got old!
 
ScottM said:
Withdrawal is not an option I ever plan to use. It would have to be something very catastrophic to even consider it.
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Like turning 70 1/2?

At that point withdrawals are mandatory.

I don't know your age, but things that seem way in the future can have a way of sneaking up on you!
 
ScottM said:
Not sure. I blew past the income limit years ago so a Roth is not really an option for me. I considered converting when I moved jobs and was doing a roll over a few years ago. But decided to keep it in a traditional IRA. Withdrawal is not an option I ever plan to use. It would have to be something very catastrophic to even consider it. But I also keep a after take invest fund that is well stocked and the 401k maxed out. I also take the extra limit deductions because I accidentally got old!
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Scott - bug your company to add a Roth 401k option. No income limits on those.
 
I believe there are some benefits on the inheritance side of things as well. But considering the Roth gets phased out for people making 200,000 + per year, and there's a $5 million tax free allowances on inheritance, I don't suppose that will have an effect on all that many estates.
 
FastEddieB said:
Like turning 70 1/2?

At that point withdrawals are mandatory.

I don't know your age, but things that seem way in the future can have a way of sneaking up on you!
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That will indeed be devastating! :yes:

But I meant withdrawals for a matter of other than retirement. For traditional 401k taking a withdrawal or a loan on your money is a bad fiscal idea. At least with the Roth you have less penalty.

A good thing to do to mitigate the risk of early withdrawal is to build an emergency fund. I have over one year's salary in mine, but I know I am the exception and not the rule, so having at least three months salary is a smart thing to do and will help in case of need while avoiding having to touch the retirement account.
 
now that my income has dropped dramatically, i have many more months of income in my emergency fund :)
 
To play the devils advocate.......

Remember Greece.....

They went broke and siezed paper assets that individuals had.....

When this country hits the tipping point, the easiest way to grab assets is just what Greece did........ And you won't be able to stop them......:no::nonod:

Buy precious metals or real estate.... Those investment vehicles are ALOT harder for the guv to grab at a whim.....:yes:
 
JeffDG said:
Not with a Roth.
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I did not know that.

I'm 64, and have a traditional. I don't think Roth was an option when I started, and I never went through the hassle and/or expense of converting it.

"A tax deferred is a tax avoided".

I have mine at Fidelity in a variety of mutual funds, and its done well for me over the years.
 
N801BH said:
To play the devils advocate.......

Remember Greece.....

They went broke and siezed paper assets that individuals had.....

When this country hits the tipping point, the easiest way to grab assets is just what Greece did........ And you won't be able to stop them......:no::nonod:

Buy precious metals or real estate.... Those investment vehicles are ALOT harder for the guv to grab at a whim.....:yes:
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Greece's problems primarily come from their use of the Euro. If they still had their own currency, they'd have devalued it. Their exports would be more competitive (tourists would be flocking there for the values) and their citizens would be experiencing some inflation, but nothing like the disaster they're dealing with.

We control our currency and it can float as needed. Also, US deficit this year of 4.1% isn't far from GDP growth which will be in the mid twos. A couple more years of even modest expansion and GDP growth will meet or exceed the deficit. That is sustainable indefinitely.
 
The kicker with the Roth is that the compounded interest remains untaxed. So no matter whether your tax bracket goes up or down in retirement, you have a benefit from it.

There was a time window (2010/2011) when you could convert conventional IRAs into Roths without an income limit by paying the taxes owed. This was a really good deal for someone who had the money for the taxes as a cash at hand. It was so good a deal they promptly did away with it after 2 years ;) .
 
weilke said:
The kicker with the Roth is that the compounded interest remains untaxed. So no matter whether your tax bracket goes up or down in retirement, you have a benefit from it.

There was a time window (2010/2011) when you could convert conventional IRAs into Roths without an income limit by paying the taxes owed. This was a really good deal for someone who had the money for the taxes as a cash at hand. It was so good a deal they promptly did away with it after 2 years ;) .
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The $100,000 cap was eliminated in 2010 and hasn't been reinstated. The two year thingie was that for a couple of years you could convert to a Roth but could split the taxes due over the next two years. That's what was done away with. You can still convert but have to pay the taxes due (and that's at your current regular tax rate, not the capital gains one) in the current year. How evah, it doesn't always make sense to convert, if your tax rate in retirement is about the same as your tax rate is now, there's not much advantage in converting unless you can leave the money in the Roth for a long time, at least 10 years.
 
FormerHangie said:
Greece's problems primarily come from their use of the Euro. If they still had their own currency, they'd have devalued it. Their exports would be more competitive (tourists would be flocking there for the values) and their citizens would be experiencing some inflation, but nothing like the disaster they're dealing with.

We control our currency and it can float as needed. Also, US deficit this year of 4.1% isn't far from GDP growth which will be in the mid twos. A couple more years of even modest expansion and GDP growth will meet or exceed the deficit. That is sustainable indefinitely.
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I respectfully disagree.....

Greece's big problem was / is their unfunded liabilities in the form of vast retirement obligations and incoming revenue stream not even close to be able to keep up....

If you think the US guv can keep manipulating the market to fend off the upcoming financial disaster, then I have a bridge to sell ya..;)..

Last number I heard a few weeks ago was the US had over 108 TRILLION dollars in unfunded liabilites....

It is just a question of time when the house of cards falls..:eek: IMHO..
 
I shared this thread with my wife, who is one of the best Enrolled Agents in Texas. She mostly deals with serious IRS problems. She sent me this note:

I read through some of it and it made my tummy hurt and my head spin to see so much bad information.
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I suspect our AME and Attorney members often have the same feeling reading some of the threads here.

Note that she didn't exclude my post. Probably an oversight on her part. ;)
 
FormerHangie said:
The $100,000 cap was eliminated in 2010 and hasn't been reinstated. The two year thingie was that for a couple of years you could convert to a Roth but could split the taxes due over the next two years. That's what was done away with. You can still convert but have to pay the taxes due (and that's at your current regular tax rate, not the capital gains one) in the current year. How evah, it doesn't always make sense to convert, if your tax rate in retirement is about the same as your tax rate is now, there's not much advantage in converting unless you can leave the money in the Roth for a long time, at least 10 years.
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Hey, cool, so it was just the split tax deal that went away, I thought the whole converting thing went back to income limits. I guess I have to go convert a bit more. I anticipate the money in my IRA to stay there for another 29 years, by that length, the compounded interest is going to be a sizeable share of the total, so the potential difference in taxes on the principal is going to be lost in the noise vs. the advantage of the tax free interest. Given the gusto with which the folks inside the beltway spend future goverment income, I dont see tax rates going down for my retirement (if that ever comes).
 
Argh. There are really good books on this topic and they're available at virtually any library. The thread is missing details and those are where they say the devil lives, of course.
 
Well, the debbil is in dem dere details, but...

The Nike slogan comes to mind: JUST DO IT.

One can agonize over this sort of thing to the point of inaction.

And one can look back (like I do) and wonder why they didn't have the foresight to put all their IRA into one sector or fund (Fidelity Technology and Fidelity Software and Computing turned out to be my huge winners).

But the sooner one gets started, the sooner the miracle of compound interest can get into gear and start working for you.

My advice:

1) JUST DO IT!

2) DIVERSIFY!

Oh, and while I'm not a gloom and doomer, having about 10% of one's assets in physically held precious metals may not be a bad idea, as insurance against one unlikely, but historically real, potential outcome.
 
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I'm currently enrolled in our company matching 401(k). Don't have a lot of 'expendable' income right now with a family of 3 (soon to be 4) and I'm still fairly low on the totem pole at work. Just happened to stumble onto some info about the different IRAs (no company-sponsored IRA product available) and thought "Hmm.. That might be a good way to stick a little money away and let it grow, but still be able to get to it in a pinch."

Per the Fidelity IRA site (https://www.fidelity.com/retirement-planning/learn-about-iras/ira-withdrawal):
Withdrawal rules for Roth IRAs
A qualified distribution from a Roth IRA is tax-free and penalty-free, provided that the five-year aging requirement has been satisfied and one of the following conditions is met:
Over age 59½
Death or disability
Qualified first-time home purchase
A non-qualified distribution is subject to taxation of earnings and a 10% additional tax unless an exception applies. For Roth IRAs, you can always remove post-tax penalty contributions (also known as “basis”) from your Roth IRA without penalty. Consult your tax advisor about your particular situation.
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So it APPEARS that you can withdraw taxed contributions from a Roth IRA at any time, while any earnings on those contributions are subject to the '5-year age + 1 extenuating circumstance' rule.

I'll have to look into the scary details a bit more...
 
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FastEddieB said:
Well, the debbil is in dem dere details, but...

The Nike slogan comes to mind: JUST DO IT.

One can agonize over this sort of thing to the point of inaction.

And one can look back (like I do) and wonder why they didn't have the foresight to put all their IRA into one sector or fund (Fidelity Technology and Fidelity Software and Computing turned out to be my huge winners).

But the sooner one gets started, the sooner the miracle of compound interest can get into gear and start working for you.

My advice:

1) JUST DO IT!

2) DIVERSIFY!

Oh, and while I'm not a gloom and doomer, having about 10% of one's assets in physically held precious metals may not be a bad idea, as insurance against one unlikely, but historically real, potential outcome.
Click to expand...

While I generally agree, folks should realize one of the debil's details is in your "compound interest" statement.

Very few of the options inside a typical crappy 401k aren't loaded down with huge fees that eat most of the profit of the investment which is not based on compound interest but on the whims of the U.S. Stock Market and any of those can always go to zero. Even bonds can, see General Motors bondholder's deal mandated by government when they decided to bail them out.

Those folks "played by the rules" and expected a return when the company was divested as it should have been. They got screwed.

I fully expect government to change the 401k and Roth rules (against my generation removing funds tax free or at lower rates) prior to my retirement. They've already pushed up the retirement age to make sure more if us are dead claiming we are *all* living longer.

So as you said, diversify. Don't put all your investments in something promised by a politician and changeable by one. And keep some of it liquid. A strategy with ALL tax deferred investments isn't diversified.

Also try finding anything with true compound interest that beats inflation. (Hint: Doesn't exist.)

There's also a balance point between paying the fund managers for performance and being cheap. I've noticed that many cheap funds are poorly managed where some more expensive funds as it relates to fees do a better job of managing capital. Fidelity is actually a good example. Their fees tend to be higher but se of their fund managers do pretty well. Their time-based funds with target retirement dates that they push real hard in 401k seminars for example, almost always underperform.

Lots of them there details.
 
denverpilot said:
While I generally agree, folks should realize one of the debil's details is in your "compound interest" statement.

Very few of the options inside a typical crappy 401k aren't loaded down with huge fees that eat most of the profit of the investment which is not based on compound interest but on the whims of the U.S. Stock Market and any of those can always go to zero. Even bonds can, see General Motors bondholder's deal mandated by government when they decided to bail them out.

Those folks "played by the rules" and expected a return when the company was divested as it should have been. They got screwed.

I fully expect government to change the 401k and Roth rules (against my generation removing funds tax free or at lower rates) prior to my retirement. They've already pushed up the retirement age to make sure more if us are dead claiming we are *all* living longer.

So as you said, diversify. Don't put all your investments in something promised by a politician and changeable by one. And keep some of it liquid. A strategy with ALL tax deferred investments isn't diversified.

Also try finding anything with true compound interest that beats inflation. (Hint: Doesn't exist.)

There's also a balance point between paying the fund managers for performance and being cheap. I've noticed that many cheap funds are poorly managed where some more expensive funds as it relates to fees do a better job of managing capital. Fidelity is actually a good example. Their fees tend to be higher but se of their fund managers do pretty well. Their time-based funds with target retirement dates that they push real hard in 401k seminars for example, almost always underperform.

Lots of them there details.
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Very well spoken Mr Nate..

:thumbsup:
 
N801BH said:
Very well spoken Mr Nate..

:thumbsup:
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Thanks. Now if I'd follow my own advice... Ha.

I had a 401k that allowed self investing inside of it for a while. Those do exist. I played with a percentage of the invested money inside it and matched the return of the various mutual funds in the other much larger portion. But it was a lot of work. I enjoyed it but it ate too much time.

I suspect like a lot of things in life if I dedicated more time to it and put a bit more discipline around it, I'd have had a few "wins" and maybe beat the odds once in a while.

But this is also coming from the guy who chickened out on Apple at $97. ;-) Made money but missed a quadruple. And those only come around a few times in a lifetime.

I timed a few others better including the former employer (call it insider information if you like but I followed all the rules and bailed on Polycom at $35 -- that was way overvalued).

All the really good "wins" have been on stuff that scared the hell out of this risk-averse kid from a non-investing paycheck-to-paycheck family background. I knew the companies were good, and read all the numbers, but always worried about the gambling aspect of the market.

Lots of sharks with more capital willing to short the small fish right out of the shark tank. The more you learn the more you realize you're standing at that guy's table on the street corner watching him move the shells around with your ball under one of them and he knows sleight of hand tricks that you don't know or haven't bought any politicians to gain access to.

You try to get in and out before you get hurt. And play with the house's money whenever you can. The similarities to Vegas are amazing. House always wins, House always gets a rake of anything that doesn't make them enough and you have a tiny house favor with the once in a while ability to beat them temporarily.

Sports betting is probably statistically safer than some of the options offered inside some 401k plans. :(
 
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