Simple Investment Question Part II

#4 02-08-2005, 09:08 AM

You also have to take into account the ability to use the traditional IRA as
a tax deduction.

The $1000 is going into the IRA basically as pre-tax dollars, where the
non-IRA is using after-tax dollars.

(Assuming the IRA is deductible.)

"Bucky" <uw_badgers[at]mail.com> wrote in message
news:1107812266.238492.223290[at]z14g2000cwz.googlegroups.com...
- quote -

> herlihyboy wrote:
> > I know there is a tax incentive in there, but if I invest in non-IRA
> > mutual funds and never draw money out until I retire, what are the
> tax
> > differences from if I invest in traditional IRA mutual funds?
> For this example, let's use a mutual fund that has zero growth in
> market value but returns 10% in dividends each year. We'll assume
> investing $1000 for ten years, reinvesting all dividends, with a 25%
> tax rate.
> After ten years, in a tax-deferred account, you will have $2594. If you
> sell it, you will have a gain of $1594, so you have to pay $1594 * 0.25
> = $398 tax, leaving you with a $1195 gain after tax.
> In the taxable account, you have to pay the tax on your dividends each
> year instead of at the end. After the first year, you get $100 in
> dividends, but you pay $25 in tax, so your total value is only $1075
> after the first year. This diminishes the compounding. Put these values
> in an Excel spreadsheet, and you will find that after ten years, your
> value will be $2061, for a gain of $1061. This is slightly less than
> the after-tax gain for the tax-deferred account.

#3 02-07-2005, 11:06 PM

"Bucky" <uw_badgers[at]mail.com> wrote:

- quote -

> herlihyboy wrote:
> > I know there is a tax incentive in there, but if I invest in non-IRA
> > mutual funds and never draw money out until I retire, what are the
> tax
> > differences from if I invest in traditional IRA mutual funds?
> For this example, let's use a mutual fund that has zero growth in
> market value but returns 10% in dividends each year. We'll assume
> investing $1000 for ten years, reinvesting all dividends, with a 25%
> tax rate.
> After ten years, in a tax-deferred account, you will have $2594. If you
> sell it, you will have a gain of $1594, so you have to pay $1594 * 0.25
> = $398 tax, leaving you with a $1195 gain after tax.
> In the taxable account, you have to pay the tax on your dividends each
> year instead of at the end. After the first year, you get $100 in
> dividends, but you pay $25 in tax, so your total value is only $1075
> after the first year. This diminishes the compounding. Put these values
> in an Excel spreadsheet, and you will find that after ten years, your
> value will be $2061, for a gain of $1061. This is slightly less than
> the after-tax gain for the tax-deferred account.

Most dividends and long term capital gains are taxed at 15% now while
withdrawals from an IRA are taxed as straight income, 25% in your example. So
while the $1195 gain after tax is figure is still correct for the IRA, the after
tax gain for the taxable account is $1261. The IRA loses.

Of course, all tax rates are subject to the whims of Congress.

-- Doug

======================================= MODERATOR'S COMMENT:
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#2 02-07-2005, 09:19 PM

Bucky - Do you have the link to an excel spreadsheet that will do this
computation-especially the taxable part you mentioned.
Thanks.
Derrick

"Bucky" <uw_badgers[at]mail.com> wrote in message
news:1107812266.238492.223290[at]z14g2000cwz.googlegroups.com...
- quote -

> herlihyboy wrote:
> > I know there is a tax incentive in there, but if I invest in non-IRA
> > mutual funds and never draw money out until I retire, what are the
> tax
> > differences from if I invest in traditional IRA mutual funds?
> For this example, let's use a mutual fund that has zero growth in
> market value but returns 10% in dividends each year. We'll assume
> investing $1000 for ten years, reinvesting all dividends, with a 25%
> tax rate.
> After ten years, in a tax-deferred account, you will have $2594. If you
> sell it, you will have a gain of $1594, so you have to pay $1594 * 0.25
> = $398 tax, leaving you with a $1195 gain after tax.
> In the taxable account, you have to pay the tax on your dividends each
> year instead of at the end. After the first year, you get $100 in
> dividends, but you pay $25 in tax, so your total value is only $1075
> after the first year. This diminishes the compounding. Put these values
> in an Excel spreadsheet, and you will find that after ten years, your
> value will be $2061, for a gain of $1061. This is slightly less than
> the after-tax gain for the tax-deferred account.

======================================= MODERATOR'S COMMENT:
Please trim the post to which you are responding. "Trim" means that except for a few lines to add context, the previous post is deleted.

#1 02-07-2005, 08:39 PM

herlihyboy wrote:
- quote -

> I know there is a tax incentive in there, but if I invest in non-IRA
> mutual funds and never draw money out until I retire, what are the
tax
> differences from if I invest in traditional IRA mutual funds?

For this example, let's use a mutual fund that has zero growth in
market value but returns 10% in dividends each year. We'll assume
investing $1000 for ten years, reinvesting all dividends, with a 25%
tax rate.

After ten years, in a tax-deferred account, you will have $2594. If you
sell it, you will have a gain of $1594, so you have to pay $1594 * 0.25
= $398 tax, leaving you with a $1195 gain after tax.

In the taxable account, you have to pay the tax on your dividends each
year instead of at the end. After the first year, you get $100 in
dividends, but you pay $25 in tax, so your total value is only $1075
after the first year. This diminishes the compounding. Put these values
in an Excel spreadsheet, and you will find that after ten years, your
value will be $2061, for a gain of $1061. This is slightly less than
the after-tax gain for the tax-deferred account.

02-07-2005, 08:19 PM

Each year you will receive a statement from the mutual fund company
stating what your capital gains and dividends are. It doesn't matter
if you sell any shares or not. Those are your share of the proceeds.
You have to pay taxes on those each year, unless you have them in tax
sheltered accounts.

JLP

http://AllThingsFinancial.blogspot.com

#-1 02-07-2005, 06:14 PM

Another simple one for some of you (hopefully). Why is it beneficial
(from a tax standpoint) to put money into mutual funds in an IRA versus
simply buying mutual funds outside of an IRA?

I know there is a tax incentive in there, but if I invest in non-IRA
mutual funds and never draw money out until I retire, what are the tax
differences from if I invest in traditional IRA mutual funds?

I know the difference if I invest in a Roth versus traditional/non-IRA.
I'm more interested in the difference between traditional and non-IRA
accounts.

Thanks all,

Ryan

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