tag:blogger.com,1999:blog-775967109474059335.post3332559816595379334..comments2023-11-13T00:52:34.306-08:00Comments on Kevin On Investing: IRAs: Traditional vs. RothUnknownnoreply@blogger.comBlogger10125tag:blogger.com,1999:blog-775967109474059335.post-70227138361200022092009-12-20T17:37:52.556-08:002009-12-20T17:37:52.556-08:00There are many IRA-related topics I didn't cov...There are many IRA-related topics I didn't cover in the original post, which is why I emphasized the importance of referring to the IRS tax publication (590). For example, the limitation on deductibility of traditional IRA contributions is not only based on income, but also on whether or not you (or your spouse) are covered by some kind of retirement plan at work. A 401(k) counts as a retirement plan. The post wasn't meant to provide comprehensive coverage of IRAs, but just to give you a basic understanding of the differences between traditional and Roth IRAs, and hopefully help you decide which makes more sense for you. To go much further than that, you must either do quite a bit of studying on your own, or consult a tax advisor.Kevinhttps://www.blogger.com/profile/03576910288369216955noreply@blogger.comtag:blogger.com,1999:blog-775967109474059335.post-61897936479995698642009-12-20T17:29:04.354-08:002009-12-20T17:29:04.354-08:00Kristen asked: "For us newbies, how do we mak...Kristen asked: "For us newbies, how do we make the connection (after contributing to a traditional or roth IRA) from your contribution to reporting it in your taxes?"<br /><br />There's a line on your tax return (form 1040, 1040A, etc.) where you enter your IRA deduction (on 2008 form 1040, it was line 32). If someone does your taxes for you, they will help you with this (if they don't ask you about IRA contributions, find someone else to do your taxes!). If you use a tax program like TurboTax, it will help you figure out if your contribution is deductible. Otherwise, you need to follow the instructions for form 1040 to determine if your contribution is deductible.<br /><br />Of course, you should have this figured out <b>before</b> you do your taxes, so that's when you should be figuring it out by reading the IRS publications or a good tax book or guide, or getting some help from your tax advisor.Kevinhttps://www.blogger.com/profile/03576910288369216955noreply@blogger.comtag:blogger.com,1999:blog-775967109474059335.post-81749990938660567692009-12-20T17:13:28.756-08:002009-12-20T17:13:28.756-08:00Kristen asked about exactly what gets taxed when y...Kristen asked about exactly what gets taxed when you take distributions from a traditional IRA (e.g., when you start taking money out of your IRA in retirement). Basically, you get taxed on everything you haven't already paid taxes on. I'll use examples to illustrate.<br /><br />Jack is single, age 25, and makes $50,000 per year. He makes a tax deductible contribution of $5,000 to a traditional IRA, and for whatever reason, never makes any more contributions. When Jack turns 65, his $5,000 contribution has grown to $80,000 (seems like a lot, but if he manages to make 7.2% annual compound return, the rule of 72 tells us that his money will double every 10 years, so in 40 years it will double 4 times: i.e., 10K,20K, 40K, 80K); Jack withdraws the entire $80,000 at age 65. Since he didn't pay any taxes on the original contribution, he will pay federal and state income taxes on the entire $80,000.<br /><br />Jill is single and makes $150,000. She makes too much to contribute to a Roth IRA, plans to maximize her 401(k) contributions, but can still afford to contribute $5000 to a traditiona IRA, and does so. From here on, we'll assume the same scenario as Jack (no more IRA contributions, 7.2% return, withdraws $80,000 at age 65). Since Jill already paid federal and state income taxes on the original $5,000, she owes taxes on $75,000 of the $80,000 withdrawal.<br /><br />These examples also point out the huge potential benefit of a Roth IRA (which unfortunately, Jill wasn't eligible to take advantage of). Let's say that Jack could've afforded to pay the taxes on his earnings, and still to contribute $5,000 to a Roth IRA (remember, no tax deduction for Roth IRA contributions). Assuming the same facts as the above scenarios, Jack could withdraw all $80,000 from his Roth IRA and pay absolutely no taxes!!! <br /><br />So, assuming you are willing to forego the immediate benefit of paying less taxes today, and that you can get a decent return on your investment over the next 40 years (and that Congress doesn't do something to take away the Roth benefits, and that you live 40 more years, etc., etc., etc.), the Roth IRA is the big winner in the long run.Kevinhttps://www.blogger.com/profile/03576910288369216955noreply@blogger.comtag:blogger.com,1999:blog-775967109474059335.post-91138823218533345632009-12-20T16:44:01.644-08:002009-12-20T16:44:01.644-08:00In answer to Kristen's question about how much...In answer to Kristen's question about how much you can make before becoming ineligible to contribute to a Roth IRA, the best thing to do is look up the answer in IRS publication 590. In my original post, click on the link to IRS Publication 590 (html version), then scroll down through the table of contents to section 2 (Roth IRAs), then click on the 7th bullet below that (Can You Contribute to a Roth IRA?).<br /><br />I highly recommend that you take a few minutes to do this. It's likely to raise other questions, but answering them gets into a course on income taxes.<br /><br />For now, I'll only add that unless you make over $100,000 (and are single), you don't have to worry about it.Kevinhttps://www.blogger.com/profile/03576910288369216955noreply@blogger.comtag:blogger.com,1999:blog-775967109474059335.post-74868462789902760602009-12-20T14:59:06.229-08:002009-12-20T14:59:06.229-08:00For us newbies, how do we make the connection (aft...For us newbies, how do we make the connection (after contributing to a traditional or roth IRA) from your contribution to reporting it in your taxes?Unknownhttps://www.blogger.com/profile/14861041528361486862noreply@blogger.comtag:blogger.com,1999:blog-775967109474059335.post-11574811058682440472009-12-20T14:42:34.562-08:002009-12-20T14:42:34.562-08:00On the traditional IRA -- the money that is tax-de...On the traditional IRA -- the money that is tax-deferred, and you won't be taxed until you take it out later -- Will you be taxed on the amount you've accumulated? Or just the amount you've put in.<br /><br />So basically, this all depends on what your current situation is -- if you can afford to get taxed right away and put into a ROTH IRA -- go for it, but if it would make more sense for you financially, put it in traditional so you can save money on your taxes now?<br /><br />Just clarifying...Unknownhttps://www.blogger.com/profile/14861041528361486862noreply@blogger.comtag:blogger.com,1999:blog-775967109474059335.post-85173783877552794782009-12-20T14:39:35.137-08:002009-12-20T14:39:35.137-08:00So how much money do you need to be making (amount...So how much money do you need to be making (amount) when you won't be eligible to contribute to a Roth IRA?Unknownhttps://www.blogger.com/profile/14861041528361486862noreply@blogger.comtag:blogger.com,1999:blog-775967109474059335.post-63283613162645067572009-12-20T14:27:33.367-08:002009-12-20T14:27:33.367-08:00I would love a follow-up article on 401k plans, in...I would love a follow-up article on 401k plans, including what questions to ask a potential employer. <br />Thank you!Marisahttps://www.blogger.com/profile/15908613265523053304noreply@blogger.comtag:blogger.com,1999:blog-775967109474059335.post-33306671999826530022009-12-20T12:34:54.913-08:002009-12-20T12:34:54.913-08:00Since this post was focused on IRAs, I didn't ...Since this post was focused on IRAs, I didn't get much into 401(k), but yes, there's a cap on 401(k) contributions, but it's much higher than that on IRA contributions. Since it deserves an article on it's own, I'll just say here that the cap is high enough that it's unlikely you'll be able to save enough to max out on 401(k) and IRA contributions if you're just getting started working.<br /><br />Regarding the second question, I was trying to get at that when I talked about it being a no-brainer if you made too much for your traditional IRA contributions to be deductible, but not enough to disqualify you for Roth IRA contributions. In this income range, the Roth benefits are not the same, but actually superior to a traditional IRA, since you would be taxed on traditional IRA distributions (when you retire and start taking money out), but Roth IRA distributions will be tax free.<br /><br />Hopefully this answers your questions, but if not, just keep asking until it's clear ;-)Kevinhttps://www.blogger.com/profile/03576910288369216955noreply@blogger.comtag:blogger.com,1999:blog-775967109474059335.post-88290821223840358312009-12-20T00:10:08.946-08:002009-12-20T00:10:08.946-08:00Is there generally a cap on the amount of money yo...Is there generally a cap on the amount of money you are allowed to put in your 401k? If so, does that depend on the company you work for?<br /><br />Also, what do you mean by, "if you make over a certain amount of money, your contributions to a traditional IRA won't be deductible." Does this mean that after that certain amount of money, you may be getting the same benefits of a roth IRA from a traditional IRA? I'm confused...Marisahttps://www.blogger.com/profile/15908613265523053304noreply@blogger.com