Comments on: Former WSJ columnist gives advice to iwillteachyoutoberich readers

By: Keith

Keith — Wed, 27 Aug 2008 15:38:15 +0000

I find this interesting because I recently took a distribution on my Roth contributions. So, I’m glad I knew of this option but I was confused with some questions asked by the company (a major one) who services my account.

When finishing the transaction over the phone, they asked me if I wanted to tax the amount now or handle it at tax time. What? I said no, send me the full amount requested.

I called back a few days later to gain some clarity. The rep said they are required to ask the question about taxes. Okay, fine I said, I just want to make sure I don’t receive a 1099. She replied they are required to generate a 1099 for all distributions regardless. Does this sound right? Will the 1099 show $0 for the taxable amount?

By: Writer's Coin

Writer's Coin — Tue, 26 Aug 2008 03:27:57 +0000

I remember reading him back in the day. Plus a story he wrote about 401(k)s somehow got linked to a post of mine and gave me my very first spike in traffic last year.

I agree that the Roth and the Em fund should be separated if at all possible. Otherwise you don’t really have an emergency fund, you have an “I’m risking my future retirement well being” fund.

By: ekrabs

ekrabs — Tue, 26 Aug 2008 02:52:41 +0000

William, all else being equal, the amount you’ll end up with is the same regardless of which vehicle you choose. But the key here is “all else being equal”, which I realize is arbitrary, but it’s the only way to realize that both vehicles use the same income tax brackets.

The first example you have provided is slightly confusing in that you have chosen the Roth to be in the 33% bracket whereas you have chosen the Traditional to be in the 15%. While something like that (not 33% but maybe 28%) can Very Much happen in real life– and exactly illustrates why considering tax brackets are so important– this is not a fair way to conclude that one retirement account type is better than the other….

In your second example, you did not factor in the opportunity cost lost in the Roth’s tax money being allowed to grow because it’s already been paid as tax. If you factor that in and compound it accordingly, I think you’ll see that it once again ends up being the same.

I hope that I am not giving you or anyone a hard time about this. I’m glad to see so many people being interested in this subject matter, as you’re all going to be far richer than I am.

I don’t know if I’m at liberty to say this, but Ramit has a forum where we can take this discussion and many more into further detail. Of course, this is Ramit’s house, so please ask him for permission if you are interested.

By: William Bay

William Bay — Tue, 26 Aug 2008 02:19:13 +0000

Jeremy,
At the risk of hijacking the post, I’ll try to keep this short.
I see your point, and you would make a considerable amount more not equal amounts. Like 200,000 more.
But I’m talking about equal amounts invested.
Say you invest the maximum amount of $5,000…

ROTH you must invest $6,650 for a total of $5,000 ($1,650 in tax every year at a total of $49,500).
TRAD $5,000 for $5,000 (no tax – and you can spend the extra money on bubble gum – something as useful as the IRS)

At the end of 30 years at 12% you would have over 1.65 million in each account (I can only dream….)

BUT… with the Traditonal IRA you would owe $247,500 assuming 15% at retirement.

It all comes down to the fact that the money you put in is ALL YOURS!!! And you can obviously see that you end up with more.

Feel free to email me directly if you feel like discussing this further. And anyone should feel free to correct my math.
Remember I’m comparing equal invested amounts… The ROTH is taxed up front and the traditional is taxed later.

By: Carlin

Carlin — Mon, 25 Aug 2008 21:22:01 +0000

I think if you use an emergency fund for major emergencies (medical bills, job loss, major repairs, etc) then you shouldn’t really have to make withdrawals that often since these items aren’t likely to happen often, and in this case using the Roth this way is a great idea, plus using it to save for a house is nice too if you’re saving over a longer time period. I think a separate savings account or something that had $2,000 or so in it for the more minor emergencies (miscellaneous car repairs, smaller medical bills, home repairs, unexpected taxes, etc) would be a good thing to have in addition to the Roth emergency fund so you wouldn’t have to sell investments and withdraw money for these more common items that are likely to occur more often. This would help make sure that the Roth withdrawals are only for major emergencies and you’re not likely to sabotage yourself by making a bunch of withdrawals each year.

By: Jeremy Freelove

Jeremy Freelove — Mon, 25 Aug 2008 19:29:02 +0000

@William:

Your analysis is incorrect because you ignore the Time Value of Money on the taxes for the first 30 years. As you mention, “with the ROTH you would have to earn $3,000 to make the $2,000 contribution (assuming 33% tax bracket)”, but you ignore the potential earnings of that additional money in the traditional IRA. If you compound this amount at the same rate, you’ll see that the two accounts end up being exactly the same.

Therefore, the only difference in analysis should be the current and expected tax brackets that you will be in.

By: William Bay

William Bay — Mon, 25 Aug 2008 16:39:53 +0000

Off topic but…
As far as the ROTH vs Trad IRAs here are some numbers:

Say you invest $2,000 each year into each ROTH and Trad:
You invest to 30 years and you are able to get 12%/yr compounded monthly.

At the end you would have a lump sum of $660,218.25

But with the ROTH you would have to earn $3,000 to make the $2,000 contribution (assuming 33% tax bracket). Which means that you have paid $30,000 in taxes spread out over 30 years. Which whittles down your net worth to 630,218.25.

With the Trad you will end up paying (say 15%) $99,032.74 in taxes all at once. Leaving you with 561,185.51!

In 30 years your net:
ROTH TRAD
630,218.25 561,185.51

I’d much rather take the $1,000 hit every year and be 90,000 wealthier.

This of course assumes no employee contribution, in which case I say “don’t pass up the free money, dummy”

By: William Bay

William Bay — Mon, 25 Aug 2008 16:28:21 +0000

If you view your retirement fund as a way out in an emergency, it blurs the line.
My wife and I are just starting our path to financial freedom – 15,000K in debt, two cars, and a mortgage. And if I were to allow ourselves to blur the line there, than whose to say the blurred line can’t extend to using credit cards when they’re paid off.

Here is why this doesn’t work (respectivley of course):
1. No matter how you look at it you are extending your debt. You are in debt to yourself – but you’re still in debt.
2. Borrowing from yourself perpetuates the borrowing mentality.
3. Whatever money you pull out is no longer earning interest (more money, more compounding), so you are in a sense sabotaging your future.

It’s an interesting discussion however, and if I didn’t have an emergency fund large enough to cover something and my Roth was big enough – I would definitely use that before going outside.
But my path is to build that small emergency fund ASAP and contribute to it afterward 10% in addition to building my ROTH

By: Jared

Jared — Sat, 23 Aug 2008 22:22:58 +0000

Great point on the Emergency fund. I contribute to my Roth IRA regularly instead of saving for a house. My money grows a lot faster in that account compared to a savings or CD, even in this turbulent economy It’s done alright.

By: Tage

Tage — Sat, 23 Aug 2008 18:27:09 +0000

Ah, yes that makes sense as well. Luckily, it shouldn’t be that hard to max your Roth, and max out your 401k up to the point where you get your employer match. But it does seem a lot more complicated than just a surface look. Thanks!