Thread: IRA at 21?
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Old 01-11-2006, 11:40 AM   #14 (permalink)
Plummie
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Location: Lexington, KY
Quote:
Originally Posted by Cimarron29414
ArellaNova,

Wow! I am impressed! An IRA would be a great way for you to spread out your nest egg. Here is the layman's difference between a conventional and Roth IRA. First of all, Roth is the congressman that introduced this IRA type as a bill, hence the name. With a conventional IRA, the amount that you put in is tax free at the time you put it in. It is taxed when you take it out - hopefully that will be when you retire. With a Roth IRA, you are taxed as you put the money in. You are not taxed when you take it out. Now, some may think that the conventional IRA sounds like a good deal because it is a tax deferment. However, there is a MAJOR flaw in the logic. Let's do the math:

Let's say you put a lump sum of $8000 in a Roth IRA. You are taxed at your lowly "just starting out in life" rate of about 21%. So you end up putting in $6320 after paying $1680 in taxes.

Now, suppose you put the same lump sum if $8000 in a Conventional IRA. You are taxed 0% and end up putting in $8000.

Now, that amount grows at 7% for 40 years.

The Conventional grows to $130,000.
The Roth grows to only $103,000.

Now, you have to pay the piper for the Conventional at a brand new "I'm a rich mo-fo" tax bracket of 29%. So you take $37,700 from your $130K and are left with $92,300. Whereas with the Roth, you don't have to pay taxes (you already did) and you are left with $103,000. So, you have made $10,700 on the deal AND instead of giving the crooks in your government $37,700, you have only given them $1680.

Someone correct me if I am wrong...
Pretty good advice, but keep in mind that the Conventional IRA has a higher compounding interest rate than a Roth IRA. So you would end up earning more per year with a Conventional, even if you are taxed more in the end. It all seems to balance out in the end.
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