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I've been trying to figure out how to make it to 20 years in the military and then call it quits.

As a new investor I'm trying to decide between a Roth IRA and a traditional IRA if I'm going to pull money out for quite a while before hitting traditional retirement age.

From what I understand, the benefit of a Roth IRA is that withdrawals up to your contributions total, and 'qualified withdrawals' after 59.5 are all tax free.

But if I want my money out before I'm 59 and a half years old, I'm going to be stuck paying income tax, plus 10% if I don't use a 72(t) distribution plan.

No matter what, it sounds like I'm going to pay tax on what goes in and on what comes out!

Assuming I do manage to retire early, I'm thinking a traditional IRA would make a lot more sense. I'll get taxed on the way out just like I would making early withdrawals on a Roth, but at least this way I can dodge taxes on the way in. Am I missing something here?
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>> I've been trying to figure out how to make it to 20 years in the military and then call it quits.

As a new investor I'm trying to decide between a Roth IRA and a traditional IRA if I'm going to pull money out for quite a while before hitting traditional retirement age.
<<

I used to work for a defense contractor. Here was the usual career path for managers there:

1) Make it 20 years in the service; start collecting a pension as early as age 38.

2) Get hired by a defense contractor, where there is an affinity for hiring retired military officers into lower and middle management.

3) Work there until you're eligible for retirement, usually 10-20 years.

4) Retire from the defense contractor in your 50s; collect TWO pensions and early retiree health insurance.

5) Re-up with the defense contractor as a "contractor" earning $80 an hour while collecting health insurance AND two pensions.

#29
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Everything #29 said, plus the option of going GS (of course, before retiring you "create" your new job). 20 yrs in the service is probably the fastest and lowest risk way to FIRE. Too bad so many young members blow their salary and reup bonuses on spinners and coffee can tailpipes. When single, a member living in quarters and taking advantage of cheap MWR concessions can live a pretty darn good live for chump change. Add in favorable tax treatment, specialty pay, etc and a guy/gal with a HS diploma can do well. If I knew then what I know now, I'd have enlisted at 17, saved my folks the cost of my education, banked $ and service years, become a mustang and retired as an O-5 (or maybe stick around for O-6 if I was having fun) in my late 30's. Heck, I work with service members now, harder than a lot of them and get half the bennies.

FoolNBlue
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No matter what, it sounds like I'm going to pay tax on what goes in and on what comes out!

Assuming I do manage to retire early, I'm thinking a traditional IRA would make a lot more sense. I'll get taxed on the way out just like I would making early withdrawals on a Roth, but at least this way I can dodge taxes on the way in. Am I missing something here?


You can also invest money in non-tax protected acccounts. Invest your money now and you will have enough to get you through to the time when the Roth IRA money can be taken out tax free.

fredinseoul
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You can also invest money in non-tax protected acccounts.

But..but..taxes! That's my money, dangit!

Seriously though, I'm trying to do what Ziggy29 and FoolNBlue were talking about. I really don't want to be an officer, but a retired CWO-4 or maybe a -5 wouldn't be bad. They still get to mess around with the fun stuff without having to explain to a colonel why two 18 year olds went out, got drunk, got caught half-naked by the local police, and yessir I understand this is my fault but they're good kids. (While keeping a straight face!)

I can't picture myself doing that.

I can picture myself living on half the salary of a senior warrant officer. It's not too far off from where I'm living right now. But I'd rather live on half that base salary, plus the interest on half my pay I'm saving right now. The fewer taxes I pay, the more that interest can amount to!

I'm thinking maxing out a traditional IRA with $8000 would make sense than using a Roth IRA if I'm going to start pulling money out in 20 years. It'll save me 15% on taxes now, which I can plug into other investments. Before I do that, I'm hoping to run the idea past the common sense detectors of Fools with a lot more experience than I have.
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As a new investor I'm trying to decide between a Roth IRA and a traditional IRA if I'm going to pull money out for quite a while before hitting traditional retirement age.

I crunched some numbers.

Assumptions:
* You have $10,000 of pre-tax income available for the purpose (and can, for the purpose of this exercise, ignore IRA contribution limits
* You are in the 30% tax bracket for ALL ordinary taxable income relevant to this account, no matter when it occurs, and the long-term capital gains tax rate is half that rate.
* You'll get a 10% profit, NOT inflation adjusted, each year, BEFORE any ongoing taxes.
* You'll invest for 10 years, and then withdraw all the money. All along the way you'll pay taxes as the law calls for.
* You want the maximum amount of final withdrawal after taxes.

Now in a taxable account, the result depends on how the profits along the way are taxed.

All short-term gains: you end up with $13,770.06.
All long-term gains, but taxed annually, you end up with $15,826.88.
All long-term gains, taxed only at withdrawal (i.e. you do buy-and-hold-forever investing, with no dividends or capital gain distributions), you end up with $16,482.77.

Next, the two major varieties of tax sheltered account. The profits are NOT taxed along the way.

Roth IRA, you end up with $14,809.34.
Conventional IRA, you end up with $18,156.20.

Why the difference?

Because most "premature" withdrawals of earnings from a Roth IRA are taxed as ordinary income, just like from a conventional IRA. The difference is the result of the tax deferral on the money initially put in the account.

What might overrule that judgment?

If you expect your tax rate in early-retirement to be HIGHER than your current tax rate. This could be because you are low income currently, or because you expect Congress to push the tax rates up substantially. 30% now versus 53% in retirement would do it.

(I don't particularly expect a tax hike like that. If you consider income taxes only. But when Congress is desperately looking for a way to bail out the bankrupt Social Security and Medicare systems, it would be no surprise for them to cast a baleful eye on early retirees.)
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Even with a traditional IRA I believe you'll still be 'stuck' with the 10% penalty unless you use a 72(t) distribution plan. Geez, I'd hate to pay income tax PLUS 10%!

At least with the Roth you can withdraw your contributions tax-free prior to age 59 1/2.

If I were in your shoes, I'd combine a Roth with a taxable account for my investment savings.

2old
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Even with a traditional IRA I believe you'll still be 'stuck' with the 10% penalty unless you use a 72(t) distribution plan. Geez, I'd hate to pay income tax PLUS 10%!

At least with the Roth you can withdraw your contributions tax-free prior to age 59 1/2.

If I were in your shoes, I'd combine a Roth with a taxable account for my investment savings.


Roth IRAs are complex for the would-be early retiree:

Withdrawals of contributions - tax free, penalty free
Early withdrawal of earnings - taxed as ordinary income, possibly subject to penalty
Fully qualifying withdrawal of earnings - tax free, penalty free

To the extent that earnings will be long-term capital gains and withdrawn "early" (as defined by the IRS), the Roth is quite possibly inferior to a taxable account. Even with a 72(t) plan.

(For the same circumstances, a conventional IRA has a small but real advantage over a taxable account. If some of your investing will be SHORT-term, that's where IRAs and 401Ks really shine.)
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Roth IRAs are complex for the would-be early retiree:

Withdrawals of contributions - tax free, penalty free
Early withdrawal of earnings - taxed as ordinary income, possibly subject to penalty
Fully qualifying withdrawal of earnings - tax free, penalty free



And that's not even all the cases!

Early withdrawal of earnings via SEPP 72(t) plan - taxed as ordinary income, not penalized
Withdrawal of amounts converted from traditional to Roth:
- before 5 years from conversion time, tax free but penalized (you paid tax at conversion time)
- after 5 years from conversion time, tax free and penalty free (treated like contributions)

In almost all scenarios, an early retiree should make every effort to withdraw from a Roth only contributions and sufficiently-aged conversions. Leave the earnings until after age 59.5.

- Erik
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