Why a Roth IRA is a Good Deal

I've weighed in before on the Roth IRA and how much I like it. After contributing to get the full match in your 410k, this is my preferred retirement savings vehicle. I was reminded of why I liked it the other day when I saw this piece from Kiplinger's. The article is titled Ride a Roth to Riches and is best summarized by this short paragraph:

If a 25-year-old contributes $4,000 each year to a Roth until he retires and makes an average annual return of only 8% on his investment, he'll have more than $1.1 million saved by the time he retires at age 65. If he had invested the money in a taxable account instead, he'd have only $810,000 if his earnings were taxed at 15%. That's more than one-fourth less money than if he'd invested in the Roth.

$300,000 more in a Roth than in a taxable account. Not bad at all, huh? Seems like a worthwhile investment to me. How about you?

Comments

[Brett McKay]

I have a Roth IRA, but am having difficulty maxing them out. Because I'm a student, I have no income. Until I have a full time job, I'm just going to try to contribute what I can every month. Every little bit helps in the long run.

[MissPinkKate]

Reading stuff like this is such a good encouragement to keep putting money in my IRA :-D

[Kurt]

No one pays 15% taxes per year when they are investing for the long-term.

[OL]

Brett: Definitely. Put whatever you can into the Roth. I wish I had started my Roth IRA when I was back in school even if it meant not fully contributing. I started as soon as I was out, but it would have given me a couple year headstart.

I also agree that doing your 401k up to matching first makes the most sense.

What are people doing when the Roth IRA is not available? Are there other accounts where you pay tax now but do not pay tax in the future? The Roth 401k comes to mind, but that tends to have limited fund/stock selection and requires that your employer offers it.

[Dirk Bell]

That is BOGUS! If we assume that the compounding rate is the same for both pre- and post-taxed accounts, the tax advantage argument described here is BOGUS! That is because the article treats the $4000 the same in both cases (as both pre-taxed and post-taxed). If someone invested $4000 after taxes, he could have invested a larger amount pre-tax without it affecting his take home pay. Yes he would pay more taxes, but he would also earn more money. The ONLY way a Roth IRA has a tax advantage is if the tax rate when the money goes in is less than the tax rate that will be applied when the money comes out (not likely for older people). So if you start out paying taxes at a low rate (like when you are young), when your income increases to the point that your tax rate is more than the tax rate will be when you retire, you should stop contributing to the Roth IRA and start contributing the larger pre-tax amount to a post-taxed account.

Keep in mind the tax on the front end is income tax, could the tax on the back end be long-term capital gains (I don't know, but it would make a difference).

So, DO THE MATH! You are comparing apples and oranges and drawing a FALSE conclusion in favor of Roth IRA's when there are times a Roth IRA is an advantage and times it is a disadvantage.