Retirement accounts: IRAs and 401ks
Traditional IRAs Introduction to traditional IRA's (Individual Retirement Accounts)
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- [MUSIC PLAYING]
- What I want to do in this video is talk a little bit
- about traditional IRA's.
- And IRA stands for Individual Retirement Account.
- And the focus in this video is the traditional IRA.
- You'll hear of other types of IRA's, especially Roth IRA's
- and SEP IRA's, but this is only on traditional.
- The gist of all of them is really it's the governments
- way of encouraging you to save for your retirement.
- But they all have slightly different details, so I'm just
- going to focus on the traditional right now.
- So let's say we are in the year 0.
- That's right now instead of year 0, let
- me write right now.
- And you have two options, you could take advantage of the
- traditional IRA, so this is the IRA scenario.
- And this is the no IRA scenario.
- Now, an IRA allows you to put up to a certain amount of your
- income aside.
- Now depending on your age and what year it is, that amount
- will change.
- But in 2010 that number is $5,000 if you're
- under the age of 50.
- And it's $6,000-- this is for an individual, not for a
- family-- and it's $6,000 if you're over the age of 50.
- I guess the rationale was probably gee, if you're over
- the age of 50, you better save even more for your retirement,
- which might only be 10 or 15 years away.
- So they give a little bit more leeway for over the age of 50.
- So let's say we're under the age of 50 and we take full
- advantage of this IRA, so we set aside $5,000.
- Here we set aside nothing.
- Now in the very short term, the advantage is that this
- $5,000 of our income will not be taxed.
- So let's say that I'm in the 32% tax bracket.
- Let me write that on the side because it will
- apply to both scenarios.
- 32% tax bracket today, because I'm making some good money.
- So if on the $5,000 only-- I'm only talking about the taxes
- on the $5,000, you're going to have to pay taxes above and
- beyond that on the rest of your income-- but today, I'm
- going to pay zero taxes on that $5,000.
- So zero taxes on the $5,000.
- Now if I don't set aside that $5,000 into an IRA, then I
- will have to pay taxes on that $5,000.
- So I'm going to have to pay $5,000 times 32%, which is
- equal to what-- I'll just get the calculator out-- so you
- get $5,000 times 0.32 is equal to $1,600 in taxes.
- So I'm going to pay $1,600 in taxes today.
- So in the year that I actually made that $5,000.
- Now I can't set aside $5,000 if I made less than $5,000.
- It's always the lower of your income or these IRA limits.
- And, of course, you're going to pay, even in this
- situation, let's say you made a $100,000, when you put the
- $5,000 aside, you're still going to have to
- pay taxes on $95,000.
- In this situation, where you didn't put the $5,000 aside,
- you're going to have to pay taxes on $100,000.
- So you're going to pay taxes on the extra
- $5,000, which is $1,600.
- Now, let's say in either situation with that $5,000 you
- want to buy and sell some securities or some
- So let's say right after you put it in the IRA account, so
- now everything is sitting in our IRA account, all of our
- transactions are sitting in this special IRA account right
- here, where we can actually buy and sell investments and
- trade them, but we can't cash them in and turn them into
- cash and then spend it on a new car or
- something like that.
- So and if we did do that before the age of 59 and 1/2,
- we'd have to pay a penalty.
- So let me write that down.
- You might immediately say hey, gee, this is a good deal.
- Why doesn't everyone always do it?
- Well the answer is, when I pull it out before 59 and 1/2,
- I pay a penalty.
- Let me write this down, because that's important to
- keep in mind.
- Pay penalty and taxes if withdrawn before 59 and 1/2.
- And once again, this is the traditional IRA.
- The Roth IRA, for example, is a little bit more flexible on
- the actual principal amount that you put into the account.
- But we're just dealing with the traditional, so this is an
- important thing to keep in mind.
- This is kind of the tradeoff that you're giving.
- So the government is saying, hey, I'm getting you an
- incentive to put this aside, and I really want to make sure
- that you leave this aside until you are ready to retire.
- So you don't get tempted when you see a nice sports car to
- cash in your IRA and use it, because you're going to have
- to pay a penalty.
- But as long as you don't actually withdraw it and turn
- into cash, you can actually buy and sell
- securities within that IRA.
- So let's say as soon as you put that $5,000, you buy
- $5,000 of stock A.
- Here we don't have $5,000 anymore, we only have $3,400
- of our original amount.
- So we buy $3,400 of stock A.
- And let's say, I don't know, 10 years in the future--
- that's going to be in either situation-- let's say that
- stock A has doubled.
- So in 10 years and you sell it, you have $10,000 here.
- You have $10,000 from sale of A.
- It's doubled.
- Here it's doubled, but you only had $3,400 of stock A, so
- now that $3,400 is worth $6,800.
- So you have $6,800 from sale of A.
- And let's say you want to put that into another stock.
- So let's say you put that all into stock B.
- And I'm painting a very rosy picture, you can't always
- ensure that stocks will double.
- And then so you buy $10,000 in this situation.
- $10,000 of B and well, I'll hold off there.
- So you buy $10,000 of B.
- And here you might say oh, I'm going to buy $6,800 of B, but
- because you are not operating within an IRA account, you're
- going to have to pay taxes on the capital gains from this
- right here.
- So capital gains are gains made from capital investments.
- In this case, the capital investment is
- investing in stocks.
- And since you owned your stock for more than one year, you at
- least will only have to pay long-term capital gains, which
- tends to be lower than short-term capital gains.
- So in this situation, you made $3,400 profit.
- You're going to have to pay 15% capital gains.
- Times 15%.
- Let's get the calculator out again.
- So $3,400 times 0.15.
- It's $510, you're going to have to pay $510.
- So you take your $6,800, pay $510 to the IRS.
- You're going to be left with $6,290.
- Remember, the reason why you have to pay taxes is this is
- not operating inside of an IRA.
- Here you are operating inside of an IRA, so you don't have
- to pay taxes.
- Now let's say you invest in stock B and then over the next
- 10 years, stock B also doubles.
- So stock B is now worth $20,000 and you sell it
- from sale of B.
- And once again it's sitting inside of your IRA, so you
- don't have to pay any capital gains on it.
- Now, in this situation, you use that $6,290 to also invest
- in stock B and, after 10 years, stock B doubles, so it
- is now $12,580.
- But once again, it's sitting outside of your IRA, you have
- to pay 15% capital gains.
- You had a $6,290 gain times 15%.
- Let's see what that is.
- Let's get the calculator.
- Where's my calculator?
- There it is.
- So you have $6,290 times 15% is equal to $943.
- And let me take that from my $12,580 minus 943.5.
- So I have $11,636.
- Let's say 20 years have passed, we're now over the age
- of 59 and 1/2, we can now withdraw from our IRA.
- Now, of course, this situation, this is cash that
- we have. We can do anything with it.
- Maybe we're now over 60 years old, this could be used for
- our retirement for our everyday expenses.
- Now this money that was sitting in an IRA, now that
- we're over the age of 60, or over 59 and 1/2, if you want
- to be particular.
- Now that we're over 60 we can withdraw the IRA without
- paying any penalty, but we will have to pay taxes.
- So we're going to withdraw, no penalties, but we will have to
- pay taxes, but the huge advantage here is once we're
- over 60, we're probably earning less money, so the
- actual tax bracket that we're in is
- probably going to be lower.
- So let's say we're in a 25% tax bracket.
- Remember, when we first made that $5,000, we were in a 32%
- tax bracket, because we were this young gun at the peak of
- his or her career making a lot of money.
- Now we're making less money, we're starting to live off of
- our savings.
- So we have to pay 25% income tax on it.
- So if we pay 25% on $20,000-- Remember, now we're actually
- withdrawing it.
- We're actually putting it into our checking account so we can
- spend it for living or whatever we
- want to do with it.
- So 25% of $20,000 is equal to $5,000 in taxes.
- So we will be left with $15,000 to do anything that we
- want with it.
- Now, compare this.
- This is $15,000 versus $11,636.
- And everything we did was completely identical, except
- for over here we took the $5,000 and
- invested within an IRA.
- Here, we took the $5,000, we had to pay taxes on it.
- Then we invested it in the exact same way-- we actually
- made very good stock investments in both
- situations-- and we ended up with a significant
- less amount of money.
- I mean, this is a $15,000 verses $11,000, that's almost
- a-- what is that?-- a 30-something percent
- difference in the total amount of money we have.
- And not only that, but this tax we have to pay, this is
- only a situation where you have a 25% tax rate.
- When you're retired, you might even have a lower tax rate
- than that, and it's deferred a good bit.
- But the real thing to think about is just, 20 years in the
- future, you're sitting on $15,000, versus, if you didn't
- participate in an IRA, you're sitting on only
- a little over $11,500.
- And of course, the main tradeoff here is that in the
- IRA situation, you really couldn't touch your money.
- So if you had an emergency, and you have to withdraw the
- money, you would have had to pay penalties on it.
- [MUSIC PLAYING]
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