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# IRA and 401K is not all that

evilryu530
i read a book missed fortune 101 that says 401ks and IRA's arent all that great. to sum the book it says why defer your tax right now for retirement when you take it out, u get taxed a shiit load more! because of the gains and stuff....what are your thoughts.
bogger
IRA = ?
401k = ?

I can't give an opinion without knowing what you're on about

P.S. IRA=Irish Republican army surely?
Afaceinthematrix
That's why you take the money out when your old, there's a certain age that you can withdrawl it at to where it's tax free.
evilryu530
no, you still get it taxed, the age is when you are allowed to get it out without getting a 10% penalty.
richard270384
As i understand it IRA's and 401K's are similar to superannuation funds here in Australia.

The idea with deferring the tax is that you earn more interest. Here is an example:

Lets say you put \$30,000 into a tax deferred investment this year and you have 20 years left until retirement. The interest rate on that investment is 10%. Lets assume that the tax rate on withdrawal is the same as the tax rate you pay on your normal earnings, say 30%.

After 20 years, your \$30,000 would be worth:
= \$30,000 x (1+ 10%) ^ 20 years
= \$201,825

You withdraw that and pay 30% tax:
= \$201,825 - (\$201,825 x 30%)
= \$141,277.50

The final amount you recieve is \$141,277.50.

Now, using the same tax and interest rate, lets assume you invested your \$30,000 in a regular investment product (i.e. not tax deferred):

You would pay 30% tax on your \$30,000 before investing it:
= \$30,000 - (\$30,000 x 30%)
= \$21,000

Your 10% interest each year would be taxed at a rate of 30%. So your net rate of return would be:
= 10% - (10% x 30%)
= 7%

After 20 years, at a rate of 7% interest your \$21,000 would be worth:
= \$21,000 x (1 + 7%) ^ 20 years
= \$81,263.37

So the final amount you recieve is \$81,263.37.

Even without any special tax concessions for leaving your money in an IRA or 401K until retirement age, you are still almost \$60,000 better off by deferring the tax.

Cheers,
Richard
unikorn
the simple idea is that whatever tax you pay now, if you defer it, you could earn interest on that tax for the whole period. So for each year the unpaid tax, will be paid ultimately, but because you earn interest on that and then that interest further compounds, what may sound not much ultimately turns out to be pretty handsome gain.

I think richard has given an extreme example. There aren't that huge gains in actual plans but yes, there are substantial gains.
Liu
Don't take it out before you retire, that's the whole point of 401k. You're only going to get fined a ton if you take it out prior to retirement.
Aiz
Since I've been working on taxes for my mom's tax return. I found out a few things about the IRA and the effects on tax savings.

Basically, why do people purchase IRA? to decrease their overall taxable income as to lower the income tax they are charged and to get themselves discounts otherwise they are not eligible or only eligible for a portion of (an example would be the various education credit deductions).

And by the time you are old enough to withdraw from your fund, you probably will not have other incomes, then adding income tax to those \$ you take out at that time would mean less income tax since your taxable income would be pretty much, only how much you take out of your IRA.

But of course, if you know you can make better use of that cash to invest or something to yield much more than what you would save with IRA, of course that's the way to go, but still, there are people who don't know much about investments or just cant get around to spend time researching investment options, so they might as well buy some IRA.
Razorback
In the US, there are a number of retirement options available to individuals. Each has varying restrictions such as income and contribution limits, distribution rules, etc. One option that has not been discussed here is the Roth IRA. If you meet the income restrictions, it is the way to go because you will never pay taxes on dividends or capital gains (as long as you wait until retirement age to withdraw the money). With the traditional IRA, 401K, SEP and most other plans, the individual simply defers tax payment until retirement age when he/she should be in a lower income tax bracket.

Hope this helps!
bigt
 Razorback wrote: In the US, there are a number of retirement options available to individuals. Each has varying restrictions such as income and contribution limits, distribution rules, etc. One option that has not been discussed here is the Roth IRA. If you meet the income restrictions, it is the way to go because you will never pay taxes on dividends or capital gains (as long as you wait until retirement age to withdraw the money). With the traditional IRA, 401K, SEP and most other plans, the individual simply defers tax payment until retirement age when he/she should be in a lower income tax bracket. Hope this helps!

I agree, the Roth IRA is better than the traditional IRA because they take the taxes out on the front end. However, I don't think most individuals will be in a lower tax bracket at retirement age with good investing and budgeting, so it's better to pay the taxes now and let investments grow tax free. I will crunch some numbers to backup my thoughts.
evilryu530
ROTH IRA is probably way better than traditional IRA. get taxed now, smaller amount, rather than get taxed when you retire on your largest amount. invest in roth IRA, high yield savings, real estate, and a 401k only if your company matches at least 50% of every dollar to 1 to 1 match. basically your company will pay for the tax, free money....other wise no match, no invest...
deanhills
If you are a good investor and have a good personal investment plan, I believe you will do better to take your money out, but if you are not that interested or really knowledgable, the Roth IRA will probably be a better option. Important to note that eventually you will be taxed on it when you make withdrawals after retirement, but the assumption is that you will receive less earnings then and taxed at a lower tax bracket. Looks as though you are doing great to study what it is about. I think one needs to do continuous study though as the bells and whistles of these schemes always change and what looks good today may be completely different in five years. Perhaps a good financial advisor or your local bank manager could give good advice and explain how it works. I think if you are not interested in investing, then solid financial advice from a reliable advisor would be a good option.
ddoonie
Einstein said it best.

The most powerful force in the universe is compound interest.

Deferring taxes allows you a larger principal balance to gain compound interest on.

Also since you defer taxes now, you can withdraw down the road at a lower rate, and be put into a lower tax bracket.