What's the biggest difference between an IRA and Roth IRA?
Answers
4085 points
EthanR answered 10 months ago …
On a traditional IRA, the money reduces your tax amount for this tax year, but when you withdraw the money down the road you will owe taxes on any gains made. With a Roth IRA, you do not enjoy the tax deduction this year, but your money will grow tax free from here on and when withdrawn, you will not owe taxes on any gains.
The Roth works best when you have a long time frame before retirement.
2222 points
readytoretire answered 10 months ago …
As Ethan said, it is a pay now or pay later issue. As a Roth IRA means that all earnings (as well as your original investment as it was after tax) is tax free, they are well suited for individuals that expect to have relatively constant tax rates, current versus retirement. A Roth also works well if you are covered by a retirement plan at work, so that your regular IRA would not be deductible. Note that a regular IRA that you made non-qualifying (non-tax deferred) contributions looks like half way between a regular and a Roth. Current earnings is tax free, but withdrawals incur tax.
The benefit of a Roth IRA drops if the current tax relief is used to increase the contribution amount.
348 points
Sensei answered 10 months ago …
While Ethan and "ready" have answered this in relation to you as a taxpayer, I'd like to address this from the government's point of view which I think is much more important.
A Roth IRA was an invention of the Clinton administration (1996) to collect more taxes and create the illusion that they were doing a good job, balancing the budget, generating huge surpluses and creating "the best economy in history" - at least according to that little snake, Robert Reich.
The truth is less aggrandizing. Allow me to present some FACTS by way of example. For simplicity, I'll assume the taxpayer has a constant 30% tax rate and contributes $1,500 each year. For reasons that will be clear in a moment, I'm also going to assume (s)he was born in 1947. The exact numbers aren't as important as the principle.
In 1996, at age 49, he puts $1,500 into his retirement account. Had he put this into an IRA, he''d get a tax deduction for that and save about $500 in tax. But if he uses a Roth IRA, he gets no deduction and the fisc benefits by collecting that tax. Multiply that by the number of people who are doing this and you get an idea of how much money we're talking about - hundreds of millions of dollars. Multiply that by the number of years we're talking about and it's in the trillions! This is how Clinton managed to "create" the huge surpluses they keep talking about.
So far, so good. Right? Now let's look at the other side ...
An IRA "matures" at age 70 1/2, meaning that this person has to start taking money out of the IRA in about 21 years (i.e. starting in 2017.) If you assume a long-term (and I'd consider 21 years to be "long term") compounded rate of return of only 7%, the Rule of 72 tells you that this $1,500 will grow to about $6,200.
As I said, I'm going to make this simple, so assume here that he takes all that money out at once - and remember, I'm only considering ONE contribution ... he's been doing this for 21 years - $31,500 in contributions and a fund value in excess of $65,000! His "formula payout" will likely be at least that amount.
With an "ordinary" IRA, he'd pay $1,860 in tax (30% x $6,200.) But with a Roth IRA, he'll pay nothing! So, the government gave up $1,860 in the future to get $500 today. That $1,360 shortfall is ONE person, for ONE year's contribution of only $1,500. Multiply that by the number of people born in 1947 who are doing this.
Think that's bad? Wait! Reality check time. He's a "baby boomer"! Almost 1/3 of Americans are "boomers". That's over 100,000,000 people! Even if only half of them have Roth IRA's, that's over 50 million. By 2034, the annual cost of our taxpayer, times 50 million just like him, costs the fisc almost $70 trillion ANNUALLY
And I haven't dealt with those who were born after 1964 (more contributions and for a longer period of time) or who contribute more than merely $1,500. (Still think Clinton created "the best economy in history"?)
But you don't have to go out to 2034. Just look at what will happen in 2017 when the first "boomers" (those born in 1947) start to collect from their Roth IRAs. About 5 million "matured" plans ... times $6,200 each that has to come out of the plans ... that's over $30 BILLION! And none of it is taxed - a loss of over $10 BILLION in government "revenues" (using "just" a 30% tax rate.) Who's going to make that up? I live in Canada so "It Ain't Me, Babe". And that's only one year! Each year it gets worse as more "boomers" reach the magic age of 70 1/2.
Two more points ...
Had the government properly managed the additional revenues they were receiving (e.g. put it in a real "lock box" and invested it in a myriad of ways I won't get into), believe it or not, they' could actually have come out ahead since they'd be earning interest on the money (and governments don't pay taxes.) But, aided and abetted by that "Little Snake", Reich, they saw this as a "surplus" (which it wasn't - it was more like deferred revenue.) Because of that, they thought they could spend it. (Yes, Bush deserves a lot of the blame for this, but don't give Pelosi, Reid, Frank and Dodd a pass. They were as much to blame - and more.) That means that the loss in tax revenue is not offset by the "lock box". It's real!!
The other point is ... where will the money come from to make the payouts to the "retirees"? Either the funds are invested in stocks, or in mutual funds which are invested in stocks. Again, how will the cash be generated? By selling the securities? And what happens to the S&P500 then? Think the money will just be put back into the market? Uh-huh. Think again. Most 70-year-olds aren't working, but they still have bills to pay (rent, food, clothing, entertainment, travel, etc.) And they have medical bills. And the government will not have the cash flow from taxes to support that "safety net" because they've already given it way via Roth IRA's.
Personally, I think Roth IRA's are a disaster waiting to happen ... and sooner; not later than many of us think. I genuinely believe the US will regret the day they enacted that bit of legislation. You think you're watching an economic meltdown now? Wait. As Al Jolson said, "You ain't seen nothin' yet!"
"Best economy in history", my butt!
4085 points
EthanR answered 10 months ago …
Sensei, you made some terrific points, in fact I had never heard about most of what you mentioned before. I would like to invite you to submit a member article to TheTycoonReport.com on that subject, as I think it is very worthwhile. Nicely done.
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