Many of our clients still in their working years do not qualify to make Roth IRA contributions (2020 income limits are $139,000 for single filers and $206,000 for married couples). But from time to time, clients do qualify to make a contribution and we often recommend doing so (maximum contribution for 2020 is $6000, and $7000 if you are over 50). We’ve done some work to quantify the value of being able to make a Roth IRA contribution, versus just leaving those funds in your taxable investment account. To review the logistics of how Roth IRA accounts work, contributions grow tax-free for your lifetime (and your heirs, if they inherit it). Another added benefit is there are no required minimum distributions that need to be withdrawn at age 72 like a Traditional IRA.
So, what is the real benefit in dollar terms? Larger after-tax returns are where you get the biggest bang for your buck. In a regular brokerage account, every year you have to pay taxes on dividends, interest and capital gains, effectively lowering your after-tax return. Some studies have pegged this “tax drag” on returns at well over 2% per year.
In our study, we looked at 3 different taxable portfolios of varying tax efficiency, all earning 8% per year PRETAX, in order to compare them to a Roth IRA:
Our study is assumed to take place over 30 years, with the contribution made in the first year. The results show how powerful Roth IRA contributions can be, if allowed.
For those that qualify, Roth IRA accounts can be extremely valuable vehicles when compared against investing in a taxable brokerage account. While there are limits on how much you can contribute, by making those contributions in the years when you are allowed, you can significantly increase your portfolio’s aftertax return, and your overall after-tax wealth.
*Always be sure to consult your tax and financial advisor before making any tax and investment decisions.
Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.