“Do I trust the government to leave Roths untouched? If you’ve been following the headlines — in particular the health care debate — you know that the deficit is big and getting bigger, which means that some taxes will, in the future, be going up. Although it’s unlikely that the government will decide to tax withdrawals (that would be double taxation), the ability to pass the account on to your heirs may find itself on the chopping block.

All in all, your best defense is likely a good offense. Just as you don’t want all your eggs in one basket, you don’t want all of your retirement funds subject to the same tax treatment. Having some in a Roth, others in a traditional IRA and still others in discretionary accounts makes you an agile investor — able to deal with whatever curve balls Congress throws your way.” 1

Wikinvest : ROTH IRA

“A Roth IRA is a retirement plan in the US which allows investments to grow without being taxed. Unlike the traditional IRA, the Roth IRA does not offer tax deduction for contributions. However, if certain requirements are met, the Roth IRA allows all investment earnings to be withdrawn tax-free.”

Well…what does that mean?

What that means is that taking the tax hit on your principal, (amount you initially invest) you can avoid paying taxes on your investment returns when you withdraw. Taking the route of pre-tax investments may appeal because you get to see a larger number in those accounts sooner, but this isn’t a panzy sprint where your first leg of the race counts more than the last…we’re talking about endgame measurement.

As with most important choices where time a major factor, you should hope for the best, prepare for the worst, and expect things to end up somewhere in the middle. One can use an 8,10, or 12 percent rate of return for a general gauge of expectations…I usually stick to 8% calculations so that I’ll be surprised but the hope of the long term 12% always makes for some interesting projections. Once you start getting up higher than that, you’re just asking for a let down. (Some, like Ibboston associates, would stick to the average stock performance (since 1926) figure of 9.79%.)

While the current ROTH contribution limits are at $5,000/yr ($6,000 if you’re over 50) I used a $5,200 annual contribution with the expectation that contribution limits will eventually go up so that we can project our values with an even $100/wk contribution.

You may delay, but time will not. Time discovers all truths and those who claim to be wasting time are only wasting themselves. While time gives its test before teaching its lesson, it isn’t difficult to understand the rules of the game and the log behind the rules and principles it uses to express its power.

compoundinterest1

If you start saving that $100/wk at 25 instead of waiting like a chump (yeah I said it) until 35, you’re talking some serious differences in what you’ll be dealing with in retirement and if you wait til 45, you can pretty much forget about early retirement.

compound2

The numbers don’t lie. Manage to bank an 8% return and you’re batting 800K higher than the saver who starts a decade later. Make it 10% and you’re pushing a million and a half…manage 12 and you’re talking a solid 3 mil or in retirement terms, annual spending (without draining the principal) of $42,000 yr vs $134,000…over three times the earning power.

If you run the figures on a 25 year old vs a 45 year old, that’s when the numbers start to get a little crazy. It isn’t often enough that readers of investment and retirement literature cite the figures for a 25 year old that saves on a regular basis…I think that one of the primary reasons for this is that it really begins to expose some of the flaws within our educational system. They can teach the students calculus, get them to memorize the periodic table, and countless other important but not ‘essential’ facts as simple as ’save $100/wk in a tax deferred account and you’re set for life.’

I think one of the other reasons is that if you’re 35,45, or older and start to run the math, realizing how much you’ve ‘lost’ by waiting for so long can become something that really throws people off and keeps them from seriously stepping up their game to catch up. (Even though time won’t let them) Plain fact is that even if a 45 year old manages to save TRIPLE ($15,600/yr or $300/wk)that of the 25 year old and still manages a 12% rate of return, they’ll only be swinging with 1.2 million come 65. I’m not sure how to make the picture more clear, save as much as you can…as early as you can…don’t touch it…and let time do the work.

While it is great to have a nice chunk of change stashed for retirement, the ability to dodge mandatory withdrawals and taxes can be even greater. But the evils of the tax man deserve their own rant.

Maybe the best present one can get is the lesson that the smallest changes really do make the biggest difference.

Merry Christmas.

Sources:
1 Sweet Deal: Is the Roth IRA right for you? : Posted: 10/30/2009 By Jean Chatzky