No. of Recommendations: 1
Abhyasi writes:

<<I must admit I'm missing something here. If the penalty is only 6% per year, how could the same money net me even more after taxes, when my capital gain tax (long-term, lets say) would be 10% or 20%, depending on my tax bracket?>>

Assume you made an excess contribution of $1,000. It earns 10%, or $100. You must pay a penalty of 6% on the excess contibution of $60. Thus, you net $40 for the year. In a taxable account, that $1K still earns 105, or $100. You pay taxes of 20%, or $20. You net $80. Which is larger, the $40 or the $80?

<<Also, I assume that both the excess contribution itself and the return it generates are penalized (E.g., the returns of an excess 10K growing for 10 years would also get taxed 6% every single year)?>>

Surprisingly, no. Only the excess contribution is penalized each year, not the earnings. Your obvious next question is, "At what point will the untaxed earnings in a Roth IRA exceed the earnings on the taxable account?" I dunno. Construct a spreadsheet, tell me your answer, and I'll verify it's correct. :-)

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