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Unread 06-17-2017, 08:47 AM   #1
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Default What is an IRA?

I am in the process of attempting to plan for an early retirement. Which I hope to do around 57. (in about 10 years).

My estimates have shown that I should attempt to have low taxes in retirement. And that currently (and hopefully this will change) there is a crazy... crazy.. difference between the tax brackets. So if you make 37K per year (gross) you will pay 25% tax. But, if you make 80K you pay the same. That is crazy. Under 37K you pay 15%

So it seems like at least some of my income in retirement must be tax free. This is where a Roth IRA comes in.

But, here is what I don't understand... what is the difference between a Roth IRA and a regular savings account? They seem to basically be the same thing? Except that Roth's have a ton of rules and restrictions. Perhaps the Roth has a better return but, so far, that is all I can see. And there is no guarantee on that.

Anyone have an idea?
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Unread 06-17-2017, 01:44 PM   #2
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Default Re: What is an IRA?

Traditional IRA vs Roth IRA

Also with a regular saving account you pay taxes on the interest every year. That is different with an IRA.
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Unread 06-17-2017, 04:09 PM   #3
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Default Re: What is an IRA?

Ok thanks... that does help. Though I have to admit I am not sure I have a ton of earnings no matter what.
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Unread 07-14-2017, 01:02 AM   #4
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Default Re: What is an IRA?

Any investment advisers that I've listened to all consistently say you should fund a Roth IRA as close to the allowed limit as you can while you are young and working. That's also what I was told by an investment counselor I consulted 10 years ago.

A regular IRA has the advantage of reducing your tax liability right now. You don't pay tax on the income that you divert to a regular IRA, until you draw it out. When that happens, you're likely to be in a lower tax bracket than you are now.

Income that is "tax free" isn't automatically better than taxable income. The income from municipal bonds is tax free. So why do you suppose everyone doesn't put all their investment money into municipal bonds? The reason is that municipal bonds tend to not generate a very high yield earnings-wise. They can get away with paying lower yields because investors know the income will be tax-free.

Your logic is a little bit shakey. One way of having low taxes in retirement is to simply have a low income when you retire. If your income is low enough you might pay no taxes. You might be in the povery bracket where the tax rate is zero percent. So would it make sense to not save any money so that you could retire poor enough to not have a tax liability? Of course not. You want to have the largest "after-tax income" you can manage. That's what will determine your standard of living. You can't figure out how to get that maximum net income by just preferring investments that are the least taxed. You have to look at the profitability of the investment.

When you say your "estimates" show you should try to have low taxes when you retire, I'ld love to know what is the feature of your "estimates" that leads you to this conclusion. Since you don't "have a ton of earnings no matter what," why are you so concerned about being taxed?

Everyone wants to have their taxes be as low as they can get them . . . now and later, during retirement. The money you put into a a Roth will be available for you to take out without you having to pay a tax on that money when you withdraw it. That's because that money came from income you already paid tax on. (Just like when you take money out of a plain old savings account, you don't get taxed on the withdrawal.) Hopefully the money sitting in the Roth will grow. The amount it grows by will be taxed when you take it out. It will get taxed based on what tax bracket you're in at the time. So a Roth doesn't really generate tax-free income. Unless of course you're quite poor in your retirement. In that case you might fall into the zero oercent tax bracket. If your income when you are 60 is less than $16,000/yr, you won't pay any income tax, no matter where the income comes from. It's unlikely you'll be that poor. Most likely, you'll be in the 15, 25 or 28 percent tax bracket. Keep in mind that there's a Standard Deduction of about $6000. That's why a person with an income of $16,000 pays no federal income tax. (You add $6000 to the top of the income in the zero percent tax bracket, which is about $10,000.)

Last edited by Rose76; 07-14-2017 at 01:43 AM.
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Unread 07-14-2017, 05:20 AM   #5
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Default Re: What is an IRA?

Quote:
Originally Posted by Rose76 View Post
Since you don't "have a ton of earnings no matter what," why are you so concerned about being taxed?
I would prefer not to spew my financial information over the internet but I do plan on having more than 37K per year.. so it seems that I have to be sure I don't put myself into the higher 25 % tax bracket and I would seem that Roth would be a way of reducing my taxable income. And providing the largest after tax income.

Quote:
The amount it grows by will be taxed when you take it out. It will get taxed based on what tax bracket you're in at the time. So a Roth doesn't really generate tax-free income.
Are you sure about that? What is the point of it. My regular IRA I thought would be taxed this way. The roth money I was told would not be included in my gross income.
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Unread 07-14-2017, 12:08 PM   #6
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Default Re: What is an IRA?

As you say in your first post, a person receiving an income of $37,000 will be in the 25% income tax bracket. You're correct about that. So, if your taxable retirement income is over $37,000, you will be in the 25%. That doesn't mean all your income will be taxed at that rate. But that will be your tax bracket. Some of your income might not be taxed. For instance, if you have income from municipal bonds, you won't be taxed on that income. The first $6,000 (roughly) of your income, no matter where it comes from, won't be taxed. The next $9,000 (roughly) will be taxed at 10%. Also remember that money you have in a retirement account doesn't become taxable, until you withdraw it. If it's Roth money, you won't get taxed on the money you, yourself, put in there. (It was already taxed before you put it in the Roth, assuming it was money you earned.) But you will get taxed on the interest/dividends that your investment in the Roth earned . . . when you take out those earnings.

Only when your total income gets over $15,000 (not counting withdrawals of deposits from the Roth) will you start paying 15% tax on it. Then, only when your total income gets over $43,000, will you start paying 25% - just on the excess amount. ($6000 plus $37,000 = $43,000.) You'll only pay 25% on the amount of total income over $43,000. (Remember not to count any withdrawals of your own contribution to the Roth.)

When you look at a federal income tax table, the tax rates you see are marginal tax rates. Marginal means that's how much you pay on all earning over the minimum money for that tax bracket. Here's a link substantiating that:

How Tax Brackets Work: Examples and Myth Busting - TaxAct

I made a mistake above. I thought there was a zero percent tax bracket. There isn't. Only the amount of "the standard deduction" is not taxed at all. So, if your total income were $9,000, you'ld get a standard deduction of about $6,000, on which you'ld pay no tax. Then you would pay 10% on the $3000 that is over the standard deduction.

So remember: When you are retired you look at your taxable income. Don't count the first roughly $6000 and don't count any withdrawals of what you put in the Roth. Look at what income is keft, after taking away thise two things. Then divide what's left into bundles. You pay 10%, 15%, and 25% on the successive bundles. 25% only applies to the top bundle.

A Roth holds two kinds of money. There is the money you, yourself, deposited into it. Then there us the interest/dividents that got added to what you put in. You never pay tax on what you put in. You do pay tax on the earnings.

"The point" of a Roth is that you don't get a tax bill every year on your earning, like you do on the interest on money in a regular savings account. You only pay tax on earnings during the year you take that money out.

If your taxable income were $38K, you'ld only pay 25% on the last $1,000 of earnings.
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Unread 07-15-2017, 08:27 AM   #7
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Default Re: What is an IRA?

Quote:
Originally Posted by Rose76 View Post
If it's Roth money, you won't get taxed on the money you, yourself, put in there. (It was already taxed before you put it in the Roth, assuming it was money you earned.) But you will get taxed on the interest/dividends that your investment in the Roth earned . . . when you take out those earnings. .
Thanks your post was helpful but I guess i still don't see that a Roth IRA is even worth it... I mean yes.. you might save some money but I don't understand what everyone is on about. Like it is the greatest thing since sliced bread. I suppose I am still going to do it so I can have some source of income that won't be factored into taxes and can drop my tax bill. I already have a Roth in the form of my workplace retirement plan. But it has only been around for a few years and doesn't have as much as my non taxable retirement money.

I am currently looking to find a "self directed" Roth IRA so I can put a lot of good investments in there. But honestly it has been hard to find.

I still think the amount of taxes on the elderly is insane.
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Unread 07-15-2017, 10:58 PM   #8
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Default Re: What is an IRA?

Money you park in a regular savings account can be withdrawn whenever you want. You don't pay tax on what you withdraw. Those withdrawals are not "income." You are simply liquidating an asset . . . like selling your gold jewelry. The proceeds are not income. Every year the interest on a savings account is reported to the IRS (unless it's very small) and the IRS sees that interest as part of your income for that year. You get taxed on that interest - every year. With a Roth, you don't have that annual bill.

I was wrong above in saying that you eventually get taxed on the earnings portion of a Roth. That was an assumption I wrongly made. You may possibly pay no taxes on even the earnings.

The money you put into a Roth IRA will earn interest or dividends or other forms of yield. At least, that's what you hope will happen. Otherwise, you may as well stuff the money in your mattress. (Roth money invested in stocks can also potentially shrink, rather than grow. Remember A.D. 2008?) That growth over and above the principal you put in may end up never getting taxed, even when you withdraw it, if you are past a certain age and the Roth has existed for a certain amount of time. That's a benefit that's pretty hard to beat.

If your tax rate is much higher now than you expect it to be when you stop working, you might be smarter to put as much as you can in a regular IRA, before you go putting money into a Roth.

A "self-directed" IRA can be good for someone with special knowledge about a particular type of investment, like real estate or commodities trading or currencies trading. Here's a link on self-directed IRAs:

https://www.fool.com/retirement/iras...e-trouble.aspx

For persons without some specialized investment knowledge, self-directed IRAs are probably not worth the trouble and risk. Picking "good investments" is like picking winning horses at the track. There's no sure-fire way to do it.

Generally, an elderly person pays less tax on a given income than a younger person with the same income will pay. One reason is that a retired person pays no Social Security payroll tax. Some elderly are eligible for a higher deduction than is available to younger folks. There are tax credits for some elderly that are not availble to the working non-elderly. Are you suggesting that the elderly pay higher taxes than the young? Or do you feel that the elderly should be taxed at a lower rate than the young?
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Unread 07-16-2017, 06:48 AM   #9
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Default Re: What is an IRA?

Quote:
Originally Posted by Rose76 View Post
Are you suggesting that the elderly pay higher taxes than the young? Or do you feel that the elderly should be taxed at a lower rate than the young?
I think elderly should be taxed at a lower rate. But I put it not necessarily like they should be taxed less than the young but less than everyone else.

Quote:
I was wrong above in saying that you eventually get taxed on the earnings portion of a Roth. That was an assumption I wrongly made. You may possibly pay no taxes on even the earnings.
Ok then that makes sense. So truly any money I put in the roth and then use for my retirement would be "tax free" when I withdraw it. That could make a major difference. In terms of the self directed IRA... I have some investments now that basically I refuse to take any money out of so essentially I am using them for retirement. So I would like to move them into the roth ira so that I could get the tax benefits. I continue to look at them.
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Unread 07-16-2017, 10:23 AM   #10
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Default Re: What is an IRA?

You have to consider where those investments are now and how moving them will affect you. From what I'm reading the only investments you can "convert" into a Roth are investments that are currently in either a traditional IRA or in a 401K. When you move either of those investments into a Roth, you pay taxes on them now, as if they were current income. (Because they were funded by untaxed wages.)
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