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View Diary: The oft-repeated lie about the capital gains tx preference (74 comments)

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  •  Roth IRA money ... (14+ / 0-)

    is taxed before it's invested in the IRA and is allowed to grow tax free, and you don't have to declare any earnings when you withdraw the money, unlike a regular IRA.

    1) Regular IRA
    - Contributions are untaxed (deducted from ordinary income)
    - Gains are not taxed as they happen, year-to-year
    - Withdrawals are taxed as ordinary income

    2) Roth IRA
    - Contributions are taxed (no deductions)
    - Gains are not taxed as they happen, year-to-year
    - Withdrawals not taxed

    So interestingly, Roth IRA's become better investments when the capital gains tax rates go up.

    •  So if capital gains and dividen rates go up (0+ / 0-)

      then less available to contribute to a Roth?  

      Romney is George W. Bush without brains.

      by thestructureguy on Sun Dec 02, 2012 at 03:25:42 PM PST

      [ Parent ]

      •  No. (0+ / 0-)

        Capital gains and dividend tax rates are irrelevant in the case of the Roth IRA.  The initial investment is reduced by an amount equal to the marginal tax rate but is allowed to grow and eventually be withdrawn without further taxation.

        $1000 invested would actually have already cost $250 in taxes if the investor has a 25% marginal tax rate. That $1000 would be able to grow in the account until withdrawn without further taxation. Any gain would actually be reduced by the initial $250 in tax. In other words, the investment would have to gain 25% before any net gain.

        A traditional IRA would be funded by money that is not taxed when it is earned. Your tax bill in the year it is put into the account would be reduced by $250 for the same $1000 investment for the same 25% marginal tax rate. The difference here is that most people have lower marginal tax rates in retirement than while working.

        Which choice is better is a complex calculation dependent on the length of time the money will be allowed to grow, the expected rate of growth, and how marginal tax rates change. A bad guess can seriously change how well your choice performs.

        Regardless, either is nearly always better than any investment in stock, bond, and mutual funds made outside of tax advantaged accounts. The same investment and  marginal tax rate as above would see $1000 taxed $250 when it is earned and again on the amount of gain it sees while it is invested. Investors will pay higher taxes on the back end when capital gains rates increase to the tax payer's marginal rate. The return of capital gains rates to that of ordinary income will make tax advantaged accounts even more attractive.

        Time makes more converts than reason. Thomas Paine, Common Sense

        by VTCC73 on Sun Dec 02, 2012 at 04:21:02 PM PST

        [ Parent ]

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