UnThreaded | Threaded | Whole Thread (12) | Ignore Thread Prev Thread | Next Thread
Author: Bspaeth Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 74759  
Subject: IRA'S Date: 5/20/1999 10:05 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
I opened a traditional IRA last year with $2000.00.

I recently read an article in the Fool about Roth IRA'S and Foolish Four Stocks. Can I open a Roth IRA this year and stuff it full of Foolish Four stocks? Do I need to convert last years traditional IRA to a Roth? Can I have both types of IRA'S at the same time? Also, would the RP-2 strategy be a good idea for a Roth? Or even (gasp!) the PPP version?
Print the post Back To Top
Author: rhecker One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10650 of 74759
Subject: Re: IRA'S Date: 5/21/1999 9:03 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
Bspaeth,

Yes, you can open a Roth this year and stuff it full of Foolish Four stocks.

You don't need to convert (but you could if you wanted to- and it might make it easier to keep your records organized) last years traditional IRA to a Roth.

Yes, you can have both types of IRAs at the same time, but the total contribution each year is still only $2000 (for example $1000 to traditional and $1000 to Roth, or $2000 to one of them and none to the other).

As for what strategy to use in a Roth, it's basically the same as choosing a stratgy outside of a Roth - personal preference. One thing you may want to keep in mind, though, is that the fees for trading inside an IRA come from that $2000 contribution. You just don't want to be buying so many stocks that it spreads your $2000 very thinly as well as makes your trading fees too large a percentage of the total money in your IRAs.



Print the post Back To Top
Author: moseykitty One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10660 of 74759
Subject: Re: IRA'S Date: 5/21/1999 2:44 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
I opened a traditional IRA last year with $2000.00.

I recently read an article in the Fool about Roth IRA'S and Foolish Four Stocks. Can I open a
Roth IRA this year and stuff it full of Foolish Four stocks? Do I need to convert last years
traditional IRA to a Roth? Can I have both types of IRA'S at the same time? Also, would the
RP-2 strategy be a good idea for a Roth? Or even (gasp!) the PPP version?

>>>>>>>

I read the Roth review as well, and felt that it perhaps oversold the Roth conversion.

It is important when comparing Roth IRAs to traditional IRAs to point out that they are mathematically identical. Paying tax on $1000, allowing what remains to grow for some years, and then withdrawing it tax-free is identical to saving $1000 tax free, allowing it to grow, and making taxable withdrawals. A simple equation, assuming a 33% tax margin and 10% annual gain for N years:

(DEPOSIT * 66%) * (1.1)^N = (DEPOSIT * (1.1)^N) * 66%

Superposition applies, and succeeding years can be treated independently. The differences are in the fringe details, which do not make a convincing case for a Roth:

- If tax rates go down in retirement (a good bet) the traditional is better.
- Since $2000 limit is after-tax money in Roth, more money can be sheltered in Roth than traditional (doesn't apply to conversions).
- Minimum distribution requirements generally favor Roth.
- Etc.

Look at this more critically before converting your IRA.



Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post Back To Top
Author: mauidude One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10669 of 74759
Subject: Re: IRA'S Date: 5/21/1999 8:55 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
moseykitty wrote:
It is important when comparing Roth IRAs to traditional IRAs to point out that they are
mathematically identical. Paying tax on $1000, allowing what remains to grow for some years, and then withdrawing it tax-free is identical to saving $1000 tax free, allowing it to grow, and making taxable withdrawals.


I'm confussed... given the ability to contribute an equal maximum in either type of IRA, don't you end up paying Uncle Sammy less with a Roth?

33% of $3000 for any number of years leaves me with my $2000 contribution for the Roth, and a tax bite of $1000 each year. Now, if I contribute yearly and the money compounds Foolishly for many years, then I end up with $100's of thousands of tax free dollars... let's say $100,000 per year tax FREE! (since we all invested so Foolishly)...

On the other hand, the first year I take a distribution from a traditional IRA, Uncle Sammy would get $33,000 in taxes, just that first year!. That amount is probably equal to the total I paid him over the course of all the years I contributed.

If someone can do the exact math, whether I'm right or wrong sorry, please help me out. My IRA calculator (read brain) doesn't do numbers too well.

Print the post Back To Top
Author: WilliamLipp Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10670 of 74759
Subject: Re: IRA'S Date: 5/21/1999 9:45 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
mauidude Date: 5/21/99 8:55 PM Number: 10669
I'm confussed... given the ability to contribute an equal maximum in either type of IRA, don't you end up paying Uncle Sammy less with a Roth?

You've fallen into the trap. The issue isn't saving taxes, the issue is maximizing wealth. You are correct that you would pay more taxes, but you would end up with the same amount of money for yourself.

Lets take an extreme example specially designed to make the numbers come out even. Suppose the tax rate is 50%. Suppose you will invest long enough to exactly double your money three times. Suppose you have $2 to invest.

Traditional example:
   invest $2
double once to $4
double second time to $8
double third time to $16
withdraw, pay $8 in taxes, spend $8

Roth example:
    Pay tax of $1, invest $1
double once to $2
double second time to $4
double third time to $8
withdraw and spend $8

In the Traditional example you pay 8 times more in taxes. But in both examples you get $8. It makes no difference for you.



Print the post Back To Top
Author: whd23 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10675 of 74759
Subject: Re: IRA'S Date: 5/22/1999 2:17 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
I take a different approach to the analysis of Roth vs. Traditional IRA. I figure that each is fully funded and that the tax difference on the Traditional IRA is invested in a non-IRA vehicle. This makes the calculation a bit more complex (I use a spreadsheet), but I find that the Roth comes out ahead even when the marginal tax rate is held constant.

My rational for doing so is as follows: IRA contributions are not deducted from your paycheck before taxes, so all the money that you send to your IRA vehicle has already been taxed. At the end of the tax year, you can write off the Traditional IRA contribution and thereby reduce your taxes owed. But if you contributed to a Roth, then it doesn't affect your taxes one way or the other.

Just throwing in my 2¢.

-Bill





Print the post Back To Top
Author: moseykitty One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10677 of 74759
Subject: Re: IRA'S Date: 5/22/1999 3:17 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
Traditional example:

invest $2
double once to $4
double second time to $8
double third time to $16
withdraw, pay $8 in taxes, spend $8


Roth example:

Pay tax of $1, invest $1
double once to $2
double second time to $4
double third time to $8
withdraw and spend $8


In the Traditional example you pay 8 times more in taxes. But in both examples you get $8. It
makes no difference for you.

>>>>>

This is a good example to demonstrate that there is no _inherent_ tax advantage to the structure of the Roth.

The true power of the Roth is what I called a detail.

Building on the above example, in the case of the Roth, one is allowed to begin with $3 instead of only $2. This is because the $2K limit applies to before tax in the trad. and after tax in the Roth.

This fact, and this fact alone as far as I can tell, is by far the most dominant in favoring the Roth over the traditional. This aspect is clearly demonstrated by using the in/out spreadsheet model suggested above.

For some odd reason I tend to feel more foolish when I can visualize the entire model as opposed to just spreadsheet results.

Feel free to let me have it if I'm missing something here.

PS -- This advantage ALSO applies to rollovers. I initially wrote, incorrectly, that it was only an issue with new deposits.




Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post Back To Top
Author: whd23 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10737 of 74759
Subject: Re: IRA'S Date: 5/24/1999 3:09 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
Here's the table comparison using my rational of
fully funding both types of IRA and investing the
tax savings of the Traditional IRA.  Since the tax
savings are invested in a non-IRA account, you will
be paying taxes on the gain.  To break even with
the Traditional IRA, your tax rate would have to
drop to %21 at the time of withdrawal.

-Bill

Traditional IRA     +   Non-IRA
--------------------------------------------
capital:     $2     |  $1
Double #1:   $4     |  $1.50 ($2 - Tax: $0.50)
Double #2:   $8     |  $2.25 ($3 - Tax: $0.75)
Double #3:  $16     |  $3.37 ($4.50 - Tax: $1.13)

Total: $11.36
(IRA $16 less $8 tax + $3.36 of Non-IRA balance)

Roth IRA (Uncle Sam gets the $1 of tax)
---------------
capital:     $2
Double #1:   $4
Double #2:   $8
Double #3:  $16

Total:      $16 (tax free)


Print the post Back To Top
Author: jocave One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10743 of 74759
Subject: Re: IRA'S Date: 5/24/1999 5:25 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
There are a couple problems with the analysis of the taxable account in this example-

1) Tax rate. Taxable accounts are taxed at capital gains rates, not income rates, which should be an advantage.
2) The taxable account need not sell everything and buy a new set of stocks at every double.

Print the post Back To Top
Author: whd23 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10747 of 74759
Subject: Re: IRA'S Date: 5/24/1999 8:55 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
On your point #1:  I agree completely.  I was just
trying to stay consistent with the original
assumptions.  Using a 20% tax rate for the non-IRA
account would yield the following numbers:

  $1
  $1.80 ($2 - Tax: $0.20)
  $2.88 ($3.60 - Tax: $0.72)
  $4.61 ($5.76 - Tax: $1.15)

total: $12.61

Your point #2:  Again, I agree with you.  It also does
not take into account any dividends generated which
would be taxed at your income tax rate.

Furthermore, this example is too simplistic to prove
the point one way or the other.  What you really have
to do is run it through a spreadsheet to see the
effects year-over-year.

The biggest effect that is missing from the Traditional
IRA, and the thing that I think really kills it, is
the fact that for $X amount of income per year, you
must withdraw $X/(1-tax_rate).  With a Roth IRA, you
would only withdraw $X amount.  This means that your
Traditional IRA gets depleted much faster then the
Roth with hurts its overall return.

-Bill

P.S.  I have a Excel spreadsheet that I wrote that
I would be glad to share with other Fools.  It
would be nice to have someone else review the work.


Print the post Back To Top
Author: cyndis Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10805 of 74759
Subject: Re: IRA'S Date: 5/26/1999 5:58 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
William Lipp says:
You've fallen into the trap. The issue isn't saving taxes, the issue is maximizing wealth. You are correct that you would pay more taxes,
but you would end up with the same amount of money for yourself.


I think you have fallen into a different trap...

To simplify, tax rate=20% forever, cap gains tax rate=15%, all investments grow @ 10% per year. Assume you have $2500 (pre-tax) to invest this year and 10 years to retirement - at which time you take a lump sum.

Scenario 1: $2000 pre-tax money to trad IRA, remaining $500 - 20% (=$to a regular investment account. In 10 years, trad IRA grows to $5187.50 which comes to $4150 after taxes. The taxable acct grows to $1037.50 which is taxed down to 1037.50 - (1037.50-400)*.15 = $941.88. Total lump sum = $5091.88.

Scenario 2: $2500 - 20% = $2000 after-tax into Roth IRA. In 10 years, this grows to $5187.50 with no taxes to be taken out.

Did I miss anything?

Cyndi

Print the post Back To Top
Author: WilliamLipp Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10807 of 74759
Subject: Re: IRA'S Date: 5/26/1999 8:50 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
cyndis Date: 5/26/99 5:58 PM Number: 10805
To simplify, tax rate=20% forever, cap gains tax rate=15%, all investments grow @ 10% per year. Assume you have $2500 (pre-tax) to invest this year and 10 years to retirement - at which time you take a lump sum.

Scenario 1: $2000 pre-tax money to trad IRA, remaining $500 - 20% (=$to a regular investment account. In 10 years, trad IRA grows to $5187.50 which comes to $4150 after taxes. The taxable acct grows to $1037.50 which is taxed down to 1037.50 - (1037.50-400)*.15 = $941.88. Total lump sum = $5091.88.

Scenario 2: $2500 - 20% = $2000 after-tax into Roth IRA. In 10 years, this grows to $5187.50 with no taxes to be taken out.

Did I miss anything?


Only that moseykitty already made the same point in message 10677.

Here's what I think the points are. In both scenarios you can put $2000 pre-tax dollars into the IRA. Although the tax amounts and tax timings are very different, the dollars to you are identical for this part of the investment (as shown by earlier post). But you can put still more dollars into a Roth IRA.

An additional important point is that this analysis depends on the assumption that tax rates stay the same. Some people expect to have lower income, still others higher income. Personally, I expect budget surpluses to be eventually result in lower tax rates in the future.

Finally, not everyone is eligible for a Roth, and not everyone is eligible for a deductible IRA. This can make the whole analysis moot.


Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post Back To Top
UnThreaded | Threaded | Whole Thread (12) | Ignore Thread Prev Thread | Next Thread
Advertisement