What I want to do in this video is talk a little bit
about traditional IRA's.
And IRA stands for Individual Retirement Account.
And the focus in this video is the traditional IRA.
You'll hear of other types of IRA's, especially Roth IRA's
and SEP IRA's, but this is only on traditional.
The gist of all of them is really it's the governments
way of encouraging you to save for your retirement.
But they all have slightly different details, so I'm just
going to focus on the traditional right now.
So let's say we are in the year 0.
That's right now instead of year 0, let
me write right now.
And you have two options, you could take advantage of the
traditional IRA, so this is the IRA scenario.
And this is the no IRA scenario.
Now, an IRA allows you to put up to a certain amount of your
income aside.
Now depending on your age and what year it is, that amount
will change.
But in 2010 that number is $5,000 if you're
under the age of 50.
And it's $6,000-- this is for an individual, not for a
family-- and it's $6,000 if you're over the age of 50.
I guess the rationale was probably gee, if you're over
the age of 50, you better save even more for your retirement,
which might only be 10 or 15 years away.
So they give a little bit more leeway for over the age of 50.
So let's say we're under the age of 50 and we take full
advantage of this IRA, so we set aside $5,000.
Here we set aside nothing.
Now in the very short term, the advantage is that this
$5,000 of our income will not be taxed.
So let's say that I'm in the 32% tax bracket.
Let me write that on the side because it will
apply to both scenarios.
32% tax bracket today, because I'm making some good money.
So if on the $5,000 only-- I'm only talking about the taxes
on the $5,000, you're going to have to pay taxes above and
beyond that on the rest of your income-- but today, I'm
going to pay zero taxes on that $5,000.
So zero taxes on the $5,000.
Now if I don't set aside that $5,000 into an IRA, then I
will have to pay taxes on that $5,000.
So I'm going to have to pay $5,000 times 32%, which is
equal to what-- I'll just get the calculator out-- so you
get $5,000 times 0.32 is equal to $1,600 in taxes.
So I'm going to pay $1,600 in taxes today.
So in the year that I actually made that $5,000.
Now I can't set aside $5,000 if I made less than $5,000.
It's always the lower of your income or these IRA limits.
And, of course, you're going to pay, even in this
situation, let's say you made a $100,000, when you put the
$5,000 aside, you're still going to have to
pay taxes on $95,000.
In this situation, where you didn't put the $5,000 aside,
you're going to have to pay taxes on $100,000.
So you're going to pay taxes on the extra
$5,000, which is $1,600.
Now, let's say in either situation with that $5,000 you
want to buy and sell some securities or some
investments.
So let's say right after you put it in the IRA account, so
now everything is sitting in our IRA account, all of our
transactions are sitting in this special IRA account right
here, where we can actually buy and sell investments and
trade them, but we can't cash them in and turn them into
cash and then spend it on a new car or
something like that.
So and if we did do that before the age of 59 and 1/2,
we'd have to pay a penalty.
So let me write that down.
You might immediately say hey, gee, this is a good deal.
Why doesn't everyone always do it?
Well the answer is, when I pull it out before 59 and 1/2,
I pay a penalty.
Let me write this down, because that's important to
keep in mind.
Pay penalty and taxes if withdrawn before 59 and 1/2.
And once again, this is the traditional IRA.
The Roth IRA, for example, is a little bit more flexible on
the actual principal amount that you put into the account.
But we're just dealing with the traditional, so this is an
important thing to keep in mind.
This is kind of the tradeoff that you're giving.
So the government is saying, hey, I'm getting you an
incentive to put this aside, and I really want to make sure
that you leave this aside until you are ready to retire.
So you don't get tempted when you see a nice sports car to
cash in your IRA and use it, because you're going to have
to pay a penalty.
But as long as you don't actually withdraw it and turn
into cash, you can actually buy and sell
securities within that IRA.
So let's say as soon as you put that $5,000, you buy
$5,000 of stock A.
Here we don't have $5,000 anymore, we only have $3,400
of our original amount.
So we buy $3,400 of stock A.
And let's say, I don't know, 10 years in the future--
that's going to be in either situation-- let's say that
stock A has doubled.
So in 10 years and you sell it, you have $10,000 here.
You have $10,000 from sale of A.
It's doubled.
Here it's doubled, but you only had $3,400 of stock A, so
now that $3,400 is worth $6,800.
So you have $6,800 from sale of A.
And let's say you want to put that into another stock.
So let's say you put that all into stock B.
And I'm painting a very rosy picture, you can't always
ensure that stocks will double.
And then so you buy $10,000 in this situation.
$10,000 of B and well, I'll hold off there.
So you buy $10,000 of B.
And here you might say oh, I'm going to buy $6,800 of B, but
because you are not operating within an IRA account, you're
going to have to pay taxes on the capital gains from this
right here.
So capital gains are gains made from capital investments.
In this case, the capital investment is
investing in stocks.
And since you owned your stock for more than one year, you at
least will only have to pay long-term capital gains, which
tends to be lower than short-term capital gains.
So in this situation, you made $3,400 profit.
You're going to have to pay 15% capital gains.
Times 15%.
Let's get the calculator out again.
So $3,400 times 0.15.
It's $510, you're going to have to pay $510.
So you take your $6,800, pay $510 to the IRS.
You're going to be left with $6,290.
Remember, the reason why you have to pay taxes is this is
not operating inside of an IRA.
Here you are operating inside of an IRA, so you don't have
to pay taxes.
Now let's say you invest in stock B and then over the next
10 years, stock B also doubles.
So stock B is now worth $20,000 and you sell it
from sale of B.
And once again it's sitting inside of your IRA, so you
don't have to pay any capital gains on it.
Now, in this situation, you use that $6,290 to also invest
in stock B and, after 10 years, stock B doubles, so it
is now $12,580.
But once again, it's sitting outside of your IRA, you have
to pay 15% capital gains.
You had a $6,290 gain times 15%.
Let's see what that is.
Let's get the calculator.
Where's my calculator?
There it is.
So you have $6,290 times 15% is equal to $943.
And let me take that from my $12,580 minus 943.5.
So I have $11,636.
Let's say 20 years have passed, we're now over the age
of 59 and 1/2, we can now withdraw from our IRA.
Now, of course, this situation, this is cash that
we have. We can do anything with it.
Maybe we're now over 60 years old, this could be used for
our retirement for our everyday expenses.
Now this money that was sitting in an IRA, now that
we're over the age of 60, or over 59 and 1/2, if you want
to be particular.
Now that we're over 60 we can withdraw the IRA without
paying any penalty, but we will have to pay taxes.
So we're going to withdraw, no penalties, but we will have to
pay taxes, but the huge advantage here is once we're
over 60, we're probably earning less money, so the
actual tax bracket that we're in is
probably going to be lower.
So let's say we're in a 25% tax bracket.
Remember, when we first made that $5,000, we were in a 32%
tax bracket, because we were this young gun at the peak of
his or her career making a lot of money.
Now we're making less money, we're starting to live off of
our savings.
So we have to pay 25% income tax on it.
So if we pay 25% on $20,000-- Remember, now we're actually
withdrawing it.
We're actually putting it into our checking account so we can
spend it for living or whatever we
want to do with it.
So 25% of $20,000 is equal to $5,000 in taxes.
So we will be left with $15,000 to do anything that we
want with it.
Now, compare this.
This is $15,000 versus $11,636.
And everything we did was completely identical, except
for over here we took the $5,000 and
invested within an IRA.
Here, we took the $5,000, we had to pay taxes on it.
Then we invested it in the exact same way-- we actually
made very good stock investments in both
situations-- and we ended up with a significant
less amount of money.
I mean, this is a $15,000 verses $11,000, that's almost
a-- what is that?-- a 30-something percent
difference in the total amount of money we have.
And not only that, but this tax we have to pay, this is
only a situation where you have a 25% tax rate.
When you're retired, you might even have a lower tax rate
than that, and it's deferred a good bit.
But the real thing to think about is just, 20 years in the
future, you're sitting on $15,000, versus, if you didn't
participate in an IRA, you're sitting on only
a little over $11,500.
And of course, the main tradeoff here is that in the
IRA situation, you really couldn't touch your money.
So if you had an emergency, and you have to withdraw the
money, you would have had to pay penalties on it.
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