Thursday, December 27, 2007

taxable vs. tax advantaged accounts

I've been always thinking which one should one choose if they have money after tax with them.
Should one invest in Mutual Funds/stocks in IRA (Traditional for this calculation) or in a taxed account?

Assumptions to max some sense:

Traditional IRA contributions are after tax money contributions
Principal : $4000
Gain per year : 10%
No further investments
Tax bracket : 25%

Age: Atleast 20 years away from retirement

With a 25% tax bracket and no annual increase in contributions this value will grow to $8244 in a taxable account or $10375 in an IRA account. If one withdraws from an IRA prematurely with a 10% penalty the value of the IRA will be lesser than the taxable account at this stage.Assuming a linear increase in the yearly rate of return the average is $671.5 /year = $6715 for 10 years.

10% penalty on $6715 = $671.5

10 year analysis
Total value of IRA on early withdrawal
10375 minus 671.5 minus 1678.5 = $ 8025
Total value of the taxable account = $8244

An analysis after 20 years reveals that the taxable account is still better if one wants to withdraw money. Will you need the money until retirement is the question ?
If not then traditional IRA is certainly a good investment.

One can use the tax calculator here



Anonymous said...

Would appreciate if you can use my referral links to sign up for the others. thanks

Ron said...

Great post. Thanks for doing the calculations for me!

You're right about the decision being based on whether you might need the money before retirement. I guess the wise choice is to have the proper insurance in place so that those life emergencies (death, disability, medical needs, college tuition, etc) don't force you into taking your retirement dollars out too soon.

Ron @