This morning I heard a Dave Ramsey moment on the radio. Dave said that a fully funded IRA, after 20 some odd years would amount to some $9 million. Ok, that's fine. We can assume the stock market never crashes and you earn Dave's token 10% rate for enough years to accumulate $9 million. That's not what I had a problem with. Every finance guy likes to tout his latest variable as if it is a fixed number.
Dave then went on to tell us that if it was a normal IRA it would all be taxable, but if it was a Roth it would be tax free! What a miracle! WHAT A LIE!
Let's compare the two. I'll make it super simple. Let's assume we invest $100 for one year and it earns Dave's famous 10%. That means at the end of the year we'd have $110. What Dave said was that if it was a traditional IRA we would owe taxes. Assuming 30% tax rate, that means $77 would be ours. However, if we had used a roth IRA it would be $110 tax free.
Where Dave EPICLY FAILS, is the assumption that we would have the same amount of money to invest in a Roth and as a Traditional IRA. Truthfully, if we had invested the $100 in a Roth IRA, that means we paid taxes on the money in the year that we contributed it. Essentially, we would have contributed $70 and paid $30 in taxes, assuming our 30% tax rate. After our year of magic 10% Dave earnings, we would have... *drum roll please* $77.
Just to recap: Traditional IRA $77, Roth IRA $77. Uh, Dave? Roth and traditional IRA are NET TAX NEUTRAL!!! Even if we still contributed the max to either account they have different maximum allowed contributions to accommodate this. Uncle Sam has to get his and ROTH vs TRADITION ARE NET TAX NEUTRAL!!!
The real questions for Roth vs Traditional are; will you be in a higher tax bracket now or later? Do you expect tax rates to be higher now or later? Do you want to owe taxes to the government or pay your tax debt now?
I'm a fan of the Roth IRA, but as I've said many times before; the real problem Dave has is that there is no one size fit's all answer.
Monday, August 27, 2012
Dave Ramsey Epic Fail: IRA Tax Savings!
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