Retirement accounts: IRAs and 401ks
Roth IRAs Introduction to Roth IRA's
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- [MUSIC PLAYING]
- What I want to do in this video is to give you the gist
- of what the Roth IRA is all about.
- And just to get an idea of why it's called the Roth IRA, it's
- named after William Roth, the late senator from Delaware.
- He helped, I guess you could say, shepherd this legislation
- in 1997 when it was first passed, so they named
- the IRA after him.
- So that's where the word comes from, so it's a special type
- of individual retirement account.
- So why did they go to the trouble of creating a new one?
- So let's think about what a traditional IRA does.
- And then I'll talk about why a Roth IRA could be interesting,
- or it's a little bit different, or why it could be
- beneficial.
- And then we'll actually see it in an example.
- So the first question is, what happens when you put money
- into a traditional or Roth IRA?
- In the traditional IRA video, you saw that it is
- tax-deferred.
- That if you were to put $5,000 in your traditional IRA, you
- are not taxed on that money.
- In the Roth IRA, it is not deferred.
- So you would actually pay taxes on that $5,000.
- So immediately, you're saying, hey, gee you know, this
- doesn't seem like that great of a thing.
- Why would I ever use it?
- I have to pay taxes on the money I put in.
- And this is the interesting thing, in both situations, as
- long as your investments stay in the either traditional or
- Roth accounts, earnings are not taxed while in account.
- This is true for both of them.
- But you're still going to say, hey Sal, the traditional still
- looks a lot better.
- I have to pay taxes on the Roth right from the get-go.
- I didn't have to pay it on the traditional.
- And then they can both grow and I can buy and sell my
- stocks or I invest in mutual funds, whatever I
- do inside of them.
- I don't pay taxes, the
- traditional still looks better.
- Now the interesting thing is what happens when you
- withdraw the money.
- So there's a lot of special circumstances on when a
- withdrawal is qualified or not, I'm not going to go and
- all the details, I really just want to give you the essence
- of why the Roth is interesting.
- So let's say you're over 59 and 1/2 years old and in the
- Roth, and your money's been there for more than five
- years, it's been seasoned.
- I'm not going to all the particulars.
- So in the traditional IRA, when you withdraw-- so let's
- say we're older than 59 and 1/2 for both, and then we do a
- withdrawal -- in the traditional IRA,
- you have to pay taxes.
- You're taxed ordinary income tax.
- While in the Roth IRA, no taxes.
- And we saw in the traditional IRA video, that this tends to
- be pretty good.
- When you're older than 59 and a half, you might be retired,
- you might be in the lower tax bracket, so you're going to
- pay the lower taxes on it.
- And it's been differed for however many years your IRA
- has been in existence.
- Now this is especially interesting, because over here
- you paid tax just on the original amount
- that you put in.
- And then you allow that original amount to grow over
- many, many, many, years and that all of a sudden you're
- not taxed at all.
- So that all of a sudden becomes a little bit
- interesting.
- This seems like a pretty good thing to have, and we're going
- to actually play with the numbers to see
- how they work out.
- Now the other interesting thing about the Roth is if you
- early withdrawal, for traditional a IRA you pay 10%
- penalty on the withdrawal, plus you get taxed.
- On the Roth IRA, if you're just taking the original
- amount you put in-- and I'll do this with a numerical
- example-- if you're just taking out your principal
- amount, no taxes or penalty on the principal.
- And you would only have to pay-- even if it's a
- non-qualified withdrawl, and there's all these special
- circumstances what's qualified and I'm not going to go to the
- details-- you would only have to pay the 10% penalty and
- taxes on earnings.
- And one of the main reasons why I'm not going into all the
- details is, one, it would make the video a little confusing.
- But also, the government is constantly
- changing the details.
- So I want you to be able to watch these videos many years
- in the future and it not to be dated, so I don't want to go
- into all of the different things that the government is
- changing from year to year.
- But let's just do a very basic example just to get
- the sense of things.
- So let's look at a traditional IRA and then we have a Roth,
- let me write IRA just to be clear that we're talking about
- an IRA in both circumstances.
- So let's say my original income amount, let's say I
- made more than $5,000, I'll just use $5,000 thousand
- dollars as my example.
- And also make another note, Roth IRA is subject to more
- limitations in terms of your total overall income.
- And that's also changing, so I don't want to be specific on
- the numbers.
- You could look that up.
- But there are ways that you can transfer traditional IRAs
- into Roth IRAs, so that's kind of a little bit of a loophole
- on being able to get around some of those restrictions.
- But anyway, I won't go into the details just yet, but just
- remember Roth IRAs there are some more limitations on
- whether or not you can put things into it.
- But if you're tricky, you might be able
- to get around them.
- So let's say you have $5,000.
- And just so you know, the limits on IRAs-- they apply to
- Roth or traditional or any combination of the two-- so if
- you're starting with $5,000.
- So in the traditional IRA, you have 0 taxes initially.
- In your Roth IRA initially, let's say you have a 32% tax
- bracket, just like in the previous video, then you'll
- pay 32% on $5,000.
- That's 0.32 times $5,000, that's $1,600.
- So you're going to pay $1,600 in taxes.
- So your amount in the account-- so in your account,
- your principal in your traditional IRA-- maybe I
- should write it out here-- starting with that $5,000,
- your principal is going to be $5,000 here.
- And it's going to only be-- you have to take
- $1,600 out for taxes.
- So it's only going to be $3,400 right there.
- Now let's say in either situation, you were to take
- that, invest it in some stocks, and then five years
- later it doubles.
- So let's say at some future point it doubles, and you sell
- those stocks.
- So that becomes $10,000 in your account there, and then
- this you invested in stocks and it doubles.
- This becomes $7,800 in your account right here.
- So this is 10 years-- I think I said five
- years into the future.
- I'm just picking that into the future.
- And let's say we're still not 59 and 1/2 years old just yet.
- Now, we could just continue to leave either of these amounts
- in our account until we're 59 and 1/2, but let's say we have
- some type of need.
- We need to give a loan to our brother-in-law or something,
- so we really want to have access to this money.
- So let's look at the situation where we withdraw.
- If we were to withdraw-- well let's think of a couple of
- situations-- if we were to withdraw $3,400.
- Let's say that's exactly what my brother-in-law
- needs, just right now.
- So if we were to withdraw $3,400 in the traditional IRA
- sense, so we take out $3,400.
- We're going to have to do two things: First, we're going to
- have to pay taxes on it, so we're going to have to pay 32%
- of that, assuming we're still in the same tax bracket.
- So $3,400 times 0.32 is equal to-- we're going to have to
- pay $1,088 in taxes.
- And we're also going to have to pay a penalty on this
- entire amount, on the $3,400.
- So we're also going to have to pay 10% penalty, $340 penalty.
- So we're going to be left with, after paying all of
- this, this is-- let me get the calculator out-- we're going
- to be left with $3,400 minus $1,088 minus
- $340 is equal to $1,972.
- So we're left with $1,972.
- Now in the Roth IRA, when you needed that money all of a
- sudden and you decided to withdraw it early, and we're
- only taking out $3,400.
- So we're taking them out, the amount that was
- our original principal.
- In the Roth IRA, we get the $3,400, because that was our
- original amount, and we pay no taxes or penalties.
- So at any point in time on the Roth IRA, you can always take
- your principal out.
- In the other types of IRAs, not only will you have to pay
- taxes on it, but you're also going to have to pay a penalty
- on top of that.
- So with the Roth IRA, one of the very positive things is,
- it gives you a lot of flexibility.
- Now, let's say you want needed to withdraw, I don't know,
- let's say you needed to withdraw $4,000.
- This is another scenario.
- $4,000 at this same point in time.
- In the traditional IRA scenario, once again you're
- going to have to pay 32% of that in taxes, so you're going
- to have to pay $4,000 times 32% in taxes and you're also
- going to have to pay plus $400.
- In the Roth IRA case, you pay nothing, you get the original
- principal you put in, that was your original amount, $3,400.
- In all of this, I'm assuming that we're not 59 and 1/2
- years old just yet.
- So in the Roth situation, you get the $3,400 free and clear,
- tax and penalty free, but the other $600, you're going to
- have to pay 32% taxes, or whatever your tax bracket is,
- and then you're also going to have to pay $60, a 10% penalty
- on just the earnings portion.
- Remember, $3,400 was your principal.
- Then if you want to take $4,000, the $600 extra, that's
- stuff that you earned, that stuff that was
- grown from the principal.
- So you're going to have to pay plus another $60 penalty.
- But it's still a much better situation, if you do the math,
- then this one here.
- So in general, if you're not sure whether you're going to
- need that money before you retire, the Roth gives you a
- lot more flexibility.
- Now let's go all the way to retirement.
- Let's say we never withdrew any money.
- We invested in another stock, and so we go 10 years later.
- So we never withdrew any money.
- We're just going to look at the retirement situation.
- And we go to our stock, and we sell it, our new stock.
- We get $20,000 there.
- Here we get $15,600.
- And, of course, in both of these situations, it's great
- that we're able to buy and sell stocks inside of these
- retirement accounts and not pay taxes.
- If these weren't sitting in retirement accounts, every
- time we bought and sold the stocks, we would have to pay
- capital gains tax.
- And you saw that in the previous video.
- Now that we are older, let's say we're 60 years old, we can
- now withdraw our money from either situation.
- There's some other little stipulations, your money has
- to be seasoned, has to be sitting there for five years
- and all that, but I won't go into the details.
- But let's see what happens when we withdraw the money.
- Let's say we have a 25% tax bracket now.
- So we're a retiree, we're earning a little bit less
- money, we are in a lower tax bracket.
- In this situation, when we withdraw from a traditional
- IRA, we are going to pay 25% in taxes, which is $5,000 in
- taxes, and we are going to be left with $15,000 for
- ourselves to spend in our retirement years.
- In the Roth IRA situation, once we're over 60 years old,
- our tax bracket doesn't matter, we just get the money.
- $15,600 free and clear.
- So if you think about it in either situation, when we
- withdrew early, the Roth IRA was much more forgiving,
- especially if we would draw less than the amount that we
- originally put in, $3,400.
- The Roth IRA does not tax us or give us penalties.
- It only does that on any money that we earn, any money in
- excess of the $3,400.
- The traditional IRA taxes us and penalizes us on
- everything.
- And then even when we go into the future, remember, in the
- traditional IRA, we didn't pay any taxes to begin with, but
- we had to pay taxes to end with.
- So when we pay taxes in the end, we're paying taxes not
- just on what we put in initially, we're also paying
- taxes on all of our cumulative earnings, right?
- We originally put in $5,000, now we're
- paying taxes on $20,000.
- So we're only going to end up with $15,000.
- While in the Roth IRA, we don't pay taxes on anything,
- for, I guess, in return for being willing to pay our taxes
- front-loaded, to pay them in the beginning, we never have
- to pay taxes on that money or on any of the earnings that
- that money makes.
- Now, I fixed the numbers here to make them close, depending
- on your tax bracket before and after, or how much growth you
- actually see in your earnings, one may be better than the
- other, but these are important considerations.
- So I just want to let you know the pros and cons.
- The Roth IRA tends to be better in terms of giving you
- the flexibility and never not worrying to pay
- taxes at the end.
- And there's one other thing-- and this is, you know,
- depending on how you view life, it might be a minor
- thing-- in the traditional IRA, when you're 70 and a
- half, they force withdrawal.
- And then, of course, you have to start
- paying taxes on things.
- In a Roth IRA, there's no age limit.
- So that's another consideration you might want
- to take into.
- [MUSIC PLAYING]
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