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