No. of Recommendations: 1
JMG asked..

"Should I be putting all my money here or should I also save 2K a year for a Roth IRA? I think I should have a Roth too because the capital gains won't be taxed and this I think will be better in the long haul, right? Help, please!!!"

Rhecker posted the following ..

"Penalties are awful things you never want to have to face. The penalty is 10% for early withdraw. So let's see... An IRA would have a 28% income tax plus a 10% penalty whereas the taxable account would have 28% income tax plus 20% capital gains tax. The penalty wins! "

A taxable account will only be charged the 28% income tax at the time the investment is made. Income tax will also be required on any dividends distributed over time. The 20% cap gains tax of a taxable acct is ONLY on the gains. Also note that all re-invested dividends will increase the cost basis and decrease the taxable cap gains later. There is no income tax paid on withdrawal of the cost basis of the investment. Whereas with a trad IRA there are no taxes paid (assuming the contribution is deductible)at the time of investment, the 28% assumed as the marginal income tax rate at the time of withdrawal and is applied to the entire withdrawal. The 10% penalty is if the IRA withdrawal is not qualified is also on the entire withdrawal - not just the gains portion.

I disagree that the IRA w/penalty wins. If the marginal tax rate is higher when the withdrawals begin, this would favor a taxable acct.

With a Roth, I believe the scenerio would be 1-pay income taxes at 28% 2-Early Withdraw 3-Pay income taxes on the earnings (but not the contributions) at 28% 4-Pay a penalty of 10%. So the penalty for withdrawing early from a Roth seems a bit steeper, and the regular IRA would win again."

There are two other alternatives for JMG to consider.

1. Retire and quit your job in January of the year you are 54 and use the 401K to fund early retirement. (This will be the year you turn 55)

401K permit the qualified distributions (meaning without penalty) if the individual quits in or after the year they turn 55. This will require that you if you have changed jobs earlier that you continue to rollover your 401K from employer to employer so that when you quit the last employer in the year you turn 55, your 401K can maintain your lifestyle until you reach 59 1/2 and can tap into any IRA's.

2. Use SEPP (substantially equal periodic payments). This can be set up for any IRA distribution prior to 59 1/2. The distributions would not be penalized.

I am unsure if this could be done with a Roth IRA.

Basially most of your retirement will be in your 401K. When you quit/retire you can roll the 401K into a trad IRA and set up SEPP. You can still Fund a Roth IRA and plan to use it when you are 59 1/2.

The primary reason to consider a Roth over a traditional IRA is if you believe that when you retire, your lifestyle expenses will cause you to withdraw from your IRA so that your AGI ratchets you into the next higher tax bracket. In other words your present marginal rate is 28% but you figure when you retire, your marginal rate may be 31% then Roth will be a better deal.

If you feel that you will require considerably less AGI in retirement and your marginal rate slips from 28%then a Traditional IRA will work out better.

With the govt and taxes, it's pay Uncle Sam now or pay him later - you will pay him!

Hope this helps.


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