Fun Fact: Senator William V. Roth Jr. of Delaware led the legislative charge to create the Roth IRA in 1997.
Refresher: With Traditional IRAs, the tax man only cares about the $$ at the end when it is withdrawn. The perk is that I’ll be a lower tax bracket when I’m old, compared to when I originally contributed the money as a young money-making machine.
With Roth IRAs, the taxman wants to get his cut at the beginning, because he doesn’t know what will happen with the $$ and when it will be used.
Essentially, contributions to a Roth IRA are taxed initially and then never again taxed. The contribution can be withdrawn at anytime, without a tax or penalty. The rules get trickier with withdrawing earnings from investments. Time to talk to a professional!
As I understand it, the perk with Roth IRAs is that the contribution is initially taxed, can be withdrawn at any time tax-free, and earning—once past a certain age (as of now, 59 1/2)—are not taxed.
When money is in a Traditional IRA or a Roth IRA, the earnings of the investments are not taxed.
So the question becomes when picking between Traditional IRAs and Roth IRAs, do you want to pay the taxman later at a lower tax bracket (Traditional) or pay the taxman now and have my *fingers-crossed* tremendous investment growth untaxed (Roth)?
Watch this Khan Academy video and understand the math to answer this question.
Now that the confusion is cleared up, let’s save for retirement! Let the countdown to Boca begin!
(Originally published on Amanda Stanhaus’s financial literacy blog: XO, Bettie.)