Tad Borek wrote:
- quote -


Gracias. Now i need to start doing some research on IRA.s, to try to
figure out
what to do when i don't know the early history of my IRA (way before i
inherited it).

OK as far as terminology, but i was using a classification that i just
saw in the new book by "the bogleheads" (which i'm sure you know
about). Anyway, I mentioned in my original post that I'm not making
any contributions and never will (not eligible to)....but i inherited
the IRA and don't know if the previous owner made deductible
contributions or not....and that may matter when i withdraw the money
in the far future (or maybe it won't).
She did work for the state of new york though (a long time ago), and
that's probably when she opened the ira.


Rich Carreiro wrote:
- quote -

selfish_shellfish2[at]yahoo.com wrote:
- quote -

I'm hopping in mid-thread but just to clarify something...when you look
at an existing IRA, the important point is how much of the dollars in
the IRA were non-deductible contributions, and how much were deductible
contributions. These aren't two types of IRAs...they are two types of
contributions that can be made to a traditional/rollover IRA. It's
important to keep track of any nondeductible contribuitons so you don't
pay tax on them at withdrawal.

"Non deductible" means "you didn't get a tax deduction when making
it...i.e., you used "after-tax" dollars. Non-ded contributions can come
about both in an IRA that you contribute to, as well as a retirement
plan that you rollover into an IRA (though it was only recently that you
were allowed to rollover after-tax contributions into Rollover IRAs).

Example: imagine a $20,000 IRA (current value) and over the years
someone made a total of $10,000 in deductible contributions and $2,000
in non-deductible contributions. You would know the latter figure from
the taxpayer's tax return, where you file a form each year that tallies
your nondeductible contributions. So right now the IRA contains:
$2,000 non-deductible contributions
$10,000 dedutible contribuitons
$8,000 tax deferred income/dividend/gains
$20k total.

The phrase you would use is that the "Basis in the IRA is $2,000". What
this means is that if you flushed out the full $20,000 as a distribution
tomorrow, $18,000 of that would be taxable income, with $2,000 being
after-tax dollars, therefore not taxable. You can consult IRS
publication 590 (www.irs.gov) for guidance on how you "order" your
contributions, when you only are taking out part of an IRA rather than
liquidating the whole account.

My quick answer to your first question is "if you leave the money in an
IRA, you're able to reinvest the dollars you would use for taxes each
year, so if your tax rate isn't substantially higher in the future
you'll "win" by leaving the money in the IRA as long as possible." Of
course if you have a credit card debt ticking along at 22% interest
annually - well heck your IRA tax advantage isn't going to be that big
so you'd probably choose to liquidate the IRA to pay off the credit
card. If your tax rate is literally zero then there's no benefit to tax
deferral in an IRA.

-Tad

selfish_shellfish2[at]yahoo.com writes:

- quote -

No -- there's only one type of traditional IRA...a traditional IRA

However, depending on your income and how you are (or are not)
covered by a retirement plan at work, your contribution to a
traditional IRA may be, on a year-by-year basis, deductible
or non-deductible. See IRS Publication 590 for the details.

And before you ask :-), there's no point in keeping non-deductible
contributions in one account and deductible contributions in
another account. For virtually all tax purposes (including
the taxability of distributions), all traditional IRA accounts are
considered aggregated into a single traditional IRA (see Form 8606).

--
Rich Carreiro rlcarr[at]animato.arlington.ma.us

Thanks, but I know it's NOT a Roth (which, i'm pretty sure, is not
considered a "trad." ira). I pretty sure there are 2 types of
traditional IRA's: Deducible and Non-Deductible. My question had to
do with which of those it was.....but certainly your comments on how to
hunt for more info. will be useful.

Elle wrote:
type-of-traditional-IRA-it-is"
- quote -

<selfish_shellfish2[at]yahoo.com> wrote
- quote -

I think the vocabulary you're using may be confusing. That's not exactly
your fault; you're not an expert on IRAs (yet!) and that's why you're here
right now.

Some ideas:

I think what you're trying to ask is whether this "inherited IRA" was
originally a "Roth IRA" or what's known simply as a "traditional IRA."

Googling for {"inherited IRA" Roth traditional} turns up a lot on this
subject.

- quote -


You do want to find out which (Roth or Traditional) it is. If it was
originally a "Roth IRA," then you should not have to pay taxes on the income
from it, assuming you meet certain requirements. If it was originally a
"Traditional IRA," then you owe taxes on income from it.

I am not sure if one can convert an "inherited traditional IRA" to
"inherited Roth IRA," but that's definitely worth checking. Google probably
has the answer.

As for records on which it was:
-- Ask the bank who you say originally held this IRA as a CD. Fidelity, one
of my brokerage houses, makes a very clear distinction between my
traditional and Roth IRA accounts.
-- Ask any other institution that held this money as an IRA for any length
of time.
-- You say you're doubtful about records in general. Still, some ideas: If
you can turn up any of the deceased's tax records, they may very well show
the deduction for IRA contributions on the front of Form 1040, near the
bottom. You might pursue getting copies of her/his past 1040s from the IRS.
I am not sure how effective this will be, but ISTM given the auditing they
do, they surely do have records of past 1040s.
-- Who did his/her taxes in the past, anyway? Contact them, even if they
charge a small fee for their trouble. If it was a Roth IRA, you want to
know.

Now that the first responder's (Rich) article has been peer reviewed,
revised and resubmitted to the journal, and is now published and on the
shelves (I stopped reading the reviews and responses after the first
sentence by the reviewer), is Rich's original answer to me basically
correct--I assume it is (i.e., the traditional IRA advantage still
holds strongly even if tax bracket stays the same). Anyone have any
idea about the issue of
"not-knowing-what-type-of-traditional-IRA-it-is" that I also stated in
my original post? thanks.

"Bucky" <uw_badgers[at]email.com> writes:
- quote -

Ha! Crap. I copied forward that error, but fixed a different
one when I redid some of Rich's numbers. Oops! (only investment
this affects is the fully-taxable one, which still loses in all
the scenarios, but not quite as horrendously badly as when we
calculated it)

- quote -

Yup.



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Rich Carreiro <rlcarr[at]animato.arlington.ma.us> writes:

- quote -

Which makes sense if you look, again, at the pre-tax
story. The Roth IRA lets you put a larger amount of
what would have been pre-tax income into a qualified
investment.

If you have $4000 to put into your Roth, and a 15% tax,
you are starting with 4705.88 of pre-tax income.

If you could put 4705.88 into a deductible IRA (or a 401k),
you end up identical to the Roth situation.

Now, supposing you have 4708.88 in pre-tax income. Your
choice may be $4000 in a Roth or $4000 in a deductible IRA
*and* invest the rest - the rest being, actually, *more*
than your tax savings for having put in the IRA contribution.

The Roth still wins, but by a lot less. The 708.88 that's
left over ($600 of which would otherwise have gone to taxes)
would have to be invested in a perfectly tax-efficient to
match the Roth performance. Of course, a low-turnover
index fund might get you very close, but it's not quite
the same thing.

While my numbers are right, the fact is that folks don't
think this way. They do think the way you describe it -
"I'm going to invest $4000. Should it be in a Roth or in
my 401k?" It's not apples-to-apples, and if that's the
way they phrase it, the answer should almost always be
the Roth simply because it means they are saving more
money, not because they are getting a better return per
dollar saved. Of course, if their 401k has a match, they
should certainly max it out at least up to the match before
doing any of the rest of this math. Worst case, they can
roll the 401k into an IRA and then into a Roth when they
leave the job in question. (or, now that 2006 is upon us,
consider the Roth 401k).

Now, from my point of view, the, er, million dollar question
is this - suppose you have an investor who's already maxed
out his 401k and makes too much to get a Roth. Remaining
options? (a) non-deductible IRA contribution
(b) very low-cost "retirement" variable annuity
(ie. Fido's at 0.25% charge, has no guaranteed
minimum death benefit)
(c) taxable investments (preferably, of course
somewhat tax efficent stuff, though)

Is there anything else?


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BreadWithSpam[at]fractious.net writes:

- quote -

I disagree with the whole chain of analysis that you follow that
with. I know what you are going to say is that starting with $1000
pre-tax, you can either put $1000 into a trad IRA or $850 into a Roth
IRA and then go from there.

What you say is true for someone who can't/won't max out the IRA
contribution. However, that line of reasoning fails for someone who
can afford to max out the IRA contribution in any situation. So that
person is going to put in $4000 no matter what.

In other words, I'm talking about a person who says "I'm putting $4000
into some kind of IRA or taxable account." For such a person, the only
alternatives are:
* $4000 into taxable account
* $4000 into Roth IRA
* $4000 non-ded contribution to trad IRA
* $4000 ded contribution to trad IRA, which lowers his
taxes by $600, giving him $600 more to spend/invest/burn/whatever.

You did catch my math error of using a 25% tax in some cases
instead of 15%. I also forgot to subtract out the initial contribution
before computing the tax in the non-ded contrib to trad IRA case.

No IRA:
$4,000 * (1 + 0.045)^30 = $14,981

Roth IRA (and base amount for trad IRAs)::
$4,000 * (1 + 0.06)^30 = $22,974

Non-ded contrib to trad IRA:
$4,000 + [($22,974 - $4,000) * (1 - 0.15)] = $20,128

Deductible contrib to trad IRA:
IRA:
$22,974 * (1 - 0.15) = $19,528
Invested tax savings:
$4000 * 0.15 * (1 + 0.45)^30 = 2,247
Total: $21,775

So after correcting for math errors, the Roth IRA moves
to the top in this example.

--
Rich Carreiro rlcarr[at]animato.arlington.ma.us

BreadWithSpam[at]fractious.net wrote:
- quote -

Good point. I did not account for this in my calculations.

Rich Carreiro wrote:
- quote -

Rich, I think you forgot your coffee this morning. =)

- quote -

If you pay $15 on $60 interest, that's 25% tax rate. But you're said
we're assuming constant 15% tax rate, right? Effective growth rate
should be 6 * 0.85 = 5.1

- quote -

This statement had 3 errors, but unfortunately, the errors did not
cancel each other out. =) First, you used 25% instead of 15% again.
Second, the tax equivalent of $4000 at a 25% rate is not 4000 * 1.25.
It is 4000 / 0.75. But we're using 15% anyways, so it should be 4000 /
0.85 = 4705.88. So the extra is 705.88. Thirdly, the effective return
is 5.1, not 4.5.

Final summary:

taxable = 4000 * (1.051)^30 = 17,789
non-deductible IRA = 4000 * (1.06)^30 * (0.85) = 19,528
Roth IRA = 4000 * (1.06)^30 = 22,974
traditional IRA = 4000 * (1.06)^30 * (0.85) + 705.88 * (1.051)^30
= 19,528 + 3139 = 22,667

Roth IRA is the winner. If you were able to invest the extra 705.88 in
the traditional IRA instead of a taxable account, you would end up with
the exact same as the Roth IRA.

Rich Carreiro <rlcarr[at]animato.arlington.ma.us> writes:

- quote -

For a Roth IRA, of course, you are investing *after tax*
dollars. (Actually, same for the "no ira" scenario). To
make this all apples-to-apples, you have to start with
$1000 *before* taxes:

No IRA:
4000 (before taxes) * (0.85) (taxes) * (1.045)^30 = $12734

Traditional IRA:
(4000 * 1.06^30 )(before taxes) * 0.85 (taxes) = $19528

Roth IRA:
4000 (before taxes) * (0.85) (taxes) * (1.06)^30 = $19528

Non-deductible IRA:
(4000 * 0.85) (after taxes!) * 1.06^30 (before taxes) = $19528
*however*: of that 19528, 3400 has *already* been taxed,
so the $19528 has a basis of 3400 and (19528 - 3400) is
taxable, so you're total after-tax net is:
(19528 - 3400) * 0.85 + 3400 = $17109.

- quote -

Er, you mean it saves you $600 in taxes.

- quote -

Assuming the same pre-tax income to invest Roth and regular
IRA come out *identical* if rates of return and taxes are
the same.

Check the math:

IRA: ($income * (1+return)^years) * (1-taxes)
Roth: ($income * (1-taxes)) * (1+return)^years


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Rich, thanks for the detailed response...I had a feeling it was in the
"faster" compounding.
I don't make any contributions, and the person i inherited from
probably did not in any recet period. Although I inherited this IRA
more than 2 years ago, and moved it to Fidelity(inherited IRA account)
from where it was before (my mother's bank CD), it occurs to me now
that I don't know if it was a 'deductible" or "non-deduct" IRA.....and
i don't think i'll ever find any records indicating which one...but
this may be a problem in the far future when i withdraw the money and
i'll have to know which one it is ???
(on my 1040 tax return last year, I did pay some tax on the RMD i
took...I believe I paid tax on 100% of the RMD, at ordinary income
rate)..

selfish_shellfish2[at]yahoo.com writes:

- quote -

The advantage is the lack of tax drag on compounding.

Suppose you experience a 15% marginal rate for your entire
life. And (to show the most favorable case for IRAs) assume
the investment gains come purely from interest. Assume in
both scenarios you invest in something that yields a constant 6%.
Assume 30 years in both scenarios, at which point you liquidate
(and in the case of the IRA, take a total distribution).

No IRA:
Each year you get $60 interest per $1000 of principal, but
you have to pay $15 tax on it. This means your effective
growth rate is only 4.5%. If you start with $4000, then
at the end of 30 years you'll have:
$4000 * (1.045)^30 = $14,981

IRA:
You compound at the full 6%, but then pay a 15% tax on
everything at the end.
$4000 * (1.06)^30 = $22,974
then
$22,974 * (1 - 0.15) = $19,528
(for a Roth IRA you'd end up with the full $22,974 since you
wouldn't pay tax on the ending distribution)

So note that the IRA gives you an advantage EVEN BEFORE you
take into account the tax deduction from the contribution.
Now let's account for that. The $4000 contribution saves
you $1000 in taxes, which you can invest at a taxable 6%
(which is 4.5% after tax) which after 30 years gives you
another $3,745.

So when you stack up the scenarios, you have:

No IRA at all: $14,981
non-deductible trad IRA: $19,528
Roth IRA: $22,974
deductible trad IRA: $23,273

Several notes to this:
(1) The trad IRA's advantage over taxable accounts shrinks the
more tax-advantaged the investment is. For example, if the
investment was a non-dividend paying stock that you held
for 30 years, "no IRA" and "non-ded trad IRA" would come
out the same.
(2) If you blow the tax savings you get from making deductible trad
IRA contributions, you've effectively made those contributions
non-deductible.
(3) Contributing to a Roth IRA may come out better or worse than
making deductible contributions to a trad IRA. It depends
on investment return, tax efficiency of investments, and
current and future tax rates. But as you can see from this
example, even in a constant low tax bracket, it's possible
to do better in a trad IRA than in a Roth IRA.

--
Rich Carreiro rlcarr[at]animato.arlington.ma.us

What's the arithmetic behind the advantage of a traditional IRA vs. a
taxable account, if one's tax bracket remains low thru life and
doesn't change at the time of withdrawal of the money (after age 59??).
. I inherited an IRA, and have been putting my REIT mutual finds in
the IRA, because i've always heard that tax-inefficient funds should go
in there. If one's tax bracket will remain the same (low)through
life, is there still an advantage? One reason i'm a bit bothered by
this is, the IRA is small (less than 10% of my portfolio), and
there's only enough room in there for the REIT fund, according to my
plan. But I also want to buy TIPS or a tips fund (i prefer the
latter, like vanguard tips fund), but this will have to go in a
taxable account. (I know about I-bonds, and they may be better for a
taxable account, though not sure if it matters if my tax bracket is
low).