Last edited Fri May 13, 2022, 03:27 AM - Edit history (1)
In my example, I chose investing $100 and it gaining $200, so that its easier to keep track of which is what as far as initial investment and gain. And over a 20 year period, a tripling is not a wild pie-in-the-sky amount, a 5.65% average annual return will do that.
ROTH IRA:
Let's say you write a check for $100 to deposit in a Roth IRA account, and over say 20 years it gains $200 tax free, for a total balance of $300 (a tripling)
When you withdraw the $300, it is tax free
TRADITIONAL IRA (TIRA):
Let's say you write a check for $100 for deposit in a Traditional IRA account. You get a tax break of say 25% if your federal + state tax bracket is 25%. Meaning you get a $25 tax break. That can be invested in a regular taxable account. Which is taxed every year, so after taxes it won't triple to $75, but rather grows to $57.36 [1]. This is what's known as the "side account" in Roth vs. Traditional IRA parlance. Many media finance writers and even supposed "experts" shamefully ignore the side account, or don't count its gains.
The Traditional IRA account itself begins with $100 in it, and over the years it gains $200 with no taxation in the meantime, for a total balance of $300.
On withdrawal, if you're still in the 25% tax bracket, you'd pay 25% tax and keep 75% of it: 75%*$300 = $225
Total after tax value : Side account + former TIRA account = $57.36 + $225 = $282.36
==========================================
Anyway, this is one illustration of how a Roth can beat an Traditional IRA (a little bit: $300 vs. $282.36, a 5.9% difference ), even though one's tax bracket is the same throughout the entire period.
If one expects their retirement tax bracket to be lower in retirement, than the Traditional IRA may come out better.
In my case, I've been happily converting small amounts of my Traditional IRA almost every year beginning in 1998, and I'm glad I did, because otherwise the required minimum distributions on my traditional IRA would eventually grow to large amounts, pushing me up a tax bracket or more. That could cause me to also pay higher Medicare premiums and does cause me to pay higher taxes on Social Security income -- two forms of "stealth taxes" that are additional to what one's tax marginal tax rate is according to the tax tables. It also pushes up the amount of my capital gains that are taxed, yet another "stealth tax".
Footnote [1] - A 5.65%/year average annual return triples an untaxed account over 20 years. Unfortunately, the side account, being a regular taxable account, is taxed every year on its gains. Say the marginal tax rate is 25% and thus the after-tax rate of return is 5.65% * (100%-25%) = 4.24%. A dollar that grows at a 4.24% after-tax rate reaches 1.0424^20 = 2.294 (well short of a tripling) over 20 years. $25 in the side account grows to $25*2.294 = $57.36
Disclosure: I'm not a financial or tax professional. I've read a lot, consulted with tax and financial advisers a lot on these darn IRAs, studied conversion calculators and done a lot of analysis, and as an engineer I know math and spreadsheets, but at the end of the day I'm just another message board rando
Edited to make clearer when there is and when there isn't taxation.
= new reply since forum marked as read