There is only one significant advantage to Roth IRAs...
(Part 3 of 5)
...and that is the ability to take the principal out early without penalty. If you want to cash out the entire thing, you are better off with a traditional or non-deferred account. However, if you only take part of the cash, the principal, a Roth is the best choice.
Consider Ted, Neal, and Ralph again. Imagine that they each make their $1000 contributions, so that T=1000, N=R=750. After a while, the amount in their accounts has doubled, and they decide they want $750 in their hands.
Ralph has $1500, removes $750, and still has $750 there. This is not a taxable event for him.
Ted has $2000. To have $750 in cash, he actually needs to withdraw ($750 / 65%), or $1154, leaving $846 in his account.
Neal has $1500. Half of whatever he withdraws will be capital-gains profit, taxed at 15%. To get $750 in hand, he has to cash out $375 in principal and $375 * 1.15 to cover the capital gains -- a total withdrawal of $806, leaving $694 in his account.
Assume that the remainder for each man doubles before they hit 59.5 years old. Ted will have a total balance of $1683, or a withdrawable balance of $1262. Ralph will have a balance of $1500, all withdrawable tax-free. Neal will have a balance of $1388, or a withdrawable balance of $1236.
Again:
This assumes contribution, g = 2, withdrawal, and g = 2 again. If the two g-values are different, it can lead to wildly varying results.
In the situation where part of the money will be withdrawn early, a Roth IRA can be the best choice.
...and that is the ability to take the principal out early without penalty. If you want to cash out the entire thing, you are better off with a traditional or non-deferred account. However, if you only take part of the cash, the principal, a Roth is the best choice.
Consider Ted, Neal, and Ralph again. Imagine that they each make their $1000 contributions, so that T=1000, N=R=750. After a while, the amount in their accounts has doubled, and they decide they want $750 in their hands.
Ralph has $1500, removes $750, and still has $750 there. This is not a taxable event for him.
Ted has $2000. To have $750 in cash, he actually needs to withdraw ($750 / 65%), or $1154, leaving $846 in his account.
Neal has $1500. Half of whatever he withdraws will be capital-gains profit, taxed at 15%. To get $750 in hand, he has to cash out $375 in principal and $375 * 1.15 to cover the capital gains -- a total withdrawal of $806, leaving $694 in his account.
Assume that the remainder for each man doubles before they hit 59.5 years old. Ted will have a total balance of $1683, or a withdrawable balance of $1262. Ralph will have a balance of $1500, all withdrawable tax-free. Neal will have a balance of $1388, or a withdrawable balance of $1236.
Again:
- Ted: $1262
- Ralph: $1500
- Neal: $1236
This assumes contribution, g = 2, withdrawal, and g = 2 again. If the two g-values are different, it can lead to wildly varying results.
In the situation where part of the money will be withdrawn early, a Roth IRA can be the best choice.
posted by Aric at 6:50 AM
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