ROTH vs. Traditional

In the course he talks about ROTH and Traditional IRAs as being roughly equal at the end of the day. (Roth) Already taxed contributions are exempt from further taxation, or (Traditional) pre-tax contributions get taxed upon withdrawal.

However he doesn’t go into detail on how exactly this works, (I realize this is not a tax accounting course…) As described though, to me the ROTH seems a far better deal?

Let’s say you make 50k, pay your taxes and then contribute your 6k into a ROTH. For that 6k, you’ve been taxed in your bracket, maybe 25% let’s say. You invest that year after year and let’s say 30 years later it’s at 1 million. It seems you’ve paid very little tax on what has become an enormous sum of money - 25% of 180k, or 45k.

But in the Traditional, it’s pretax dollars. You make the same contributions, it becomes 1 million again. But now you owe 25% or more depending on the tax bracket, on that 1 million. Possibly 250k or more. That seems like a terrible idea.
Unless you’re only taxed on the capital gains? Which would still be a lot more that 45k from the ROTH. Or in some other way?

Obviously this is a very, very simplistic example. I must be missing some things. Just trying to understand how exactly you get taxed in the Traditional IRA.

Additionally, what if the market is doing fantastic for many years and your ROTH grows exceptionally well. The idea of not being taxed at all down the road, as it grows and grows, seems very appealing.

It seems on first glance though that the ROTH is the way to go.

Thanks for any comments.

Christopher,

I would agree with you. Generally, the balances in a traditional and Roth IRA grow the same way with the same investments. But because of the inflation in prices and value, one would end up paying more taxes in a traditional account throughout their lifetime. Even if the person is in the same tax bracket now and 30 years later, the amount of taxes paid for a traditional account would also be inflated with time.

But I’m guessing the time value of money plays an important role. The same amount of money, let’s say $1000, has more value today than it would in the future. For example, having $1000 today allows you to buy 500 apples. But if you choose to receive $0 today and instead receive $1000 in 30 years from now, that maybe only allows you to buy 200 apples. Imagine that $1000 to be the amount of taxes you have to pay today for Roth IRA versus not paying it for a traditional IRA. What you can do with that $1000 dollars today may bring more value to your life and wellbeing than waiting 30 years before you can access that money and growth.

Very good point thank you. The numbers in my example seemed to make so much sense yesterday lol. I often get bogged down in these details.

I think you’re asking the right questions - shows you really understand the material! :slight_smile: