Taxable (Roth) VS Tax Deferred (IRA & 401k) Explanation
Taxable (Roth) VS Tax Deferred (IRA & 401k) Explanation
Using the Taxable (Roth) VS Tax Deferred (IRA & 401k) Graphic as a visual aid, here is a simple explanation of the difference between the two types of Retirement Accounts.
Taxable: You receive your paycheck the same way as usual. You pay taxes on your Gross Pay (B3) and this gives you your Net Pay (B12). Your 10% retirement fund is then calculated from your Net Pay (B5) and then the rest of your budget is paid from the discretionary income.
Tax Deferred: There are two options for tax deferred accounts.
Option 1 increases your monthly Cash Flow (you feel richer)
Option 2 maximizes your retirement accounts (you have the same cash flow as a taxable account)
Tax Deferred - Cash Flow: You save the same 10% of Gross Income as you would have if you were using the Taxable account (Red Arrow to E19). However, since you aren't saving 10% of your gross income you have an increase in disposable income each month of $69 (Purple Arrow to E12). Ultimately, you will have the same amount saved up as the Taxable route, however you will still have to pay taxes (as much as 35%) during retirement. You will have a better life now but your retirement won't be nearly as nice as it could have been.
Tax Deferred - Maximize Retirement: You save 10% of your Gross Pay (Blue Arrow to H15). This would be a full $400 per month. While your Disposable income is the same as the Taxable option (Green Arrow to H17) you are saving an extra $88 per month. With compounding interest this extra $88 each month could mean an extra $130,000 after 30 years at 8%. Again, you will still have to pay taxes (as much as 35%) on this amount during retirement.
Questions:
1. Do you believe taxes will be higher or lower in the future and why? Defend!!!
2. If you had to use a Tax Deferred account which option would you use (Cash Flow or Maximize Retirement) and why? Defend!!!
3. Using the Taxable (Roth) VS Tax Deferred (IRA & 401k) Graphic what would happen if the individual who chose the Maximize Retirement plan retired early (once they had saved $312)? Does the individual who chooses the Cash Flow plan have the same problem?
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