What I want to do in this video is to give you the gist
of what the Roth IRA is all about.
And just to get an idea of why it's called the Roth IRA, it's
named after William Roth, the late senator from Delaware.
He helped, I guess you could say, shepherd this legislation
in 1997 when it was first passed, so they named
the IRA after him.
So that's where the word comes from, so it's a special type
of individual retirement account.
So why did they go to the trouble of creating a new one?
So let's think about what a traditional IRA does.
And then I'll talk about why a Roth IRA could be interesting,
or it's a little bit different, or why it could be
And then we'll actually see it in an example.
So the first question is, what happens when you put money
into a traditional or Roth IRA?
In the traditional IRA video, you saw that it is
That if you were to put $5,000 in your traditional IRA, you
are not taxed on that money.
In the Roth IRA, it is not deferred.
So you would actually pay taxes on that $5,000.
So immediately, you're saying, hey, gee you know, this
doesn't seem like that great of a thing.
Why would I ever use it?
I have to pay taxes on the money I put in.
And this is the interesting thing, in both situations, as
long as your investments stay in the either traditional or
Roth accounts, earnings are not taxed while in account.
This is true for both of them.
But you're still going to say, hey Sal, the traditional still
looks a lot better.
I have to pay taxes on the Roth right from the get-go.
I didn't have to pay it on the traditional.
And then they can both grow and I can buy and sell my
stocks or I invest in mutual funds, whatever I
do inside of them.
I don't pay taxes, the
traditional still looks better.
Now the interesting thing is what happens when you
withdraw the money.
So there's a lot of special circumstances on when a
withdrawal is qualified or not, I'm not going to go and
all the details, I really just want to give you the essence
of why the Roth is interesting.
So let's say you're over 59 and 1/2 years old and in the
Roth, and your money's been there for more than five
years, it's been seasoned.
I'm not going to all the particulars.
So in the traditional IRA, when you withdraw-- so let's
say we're older than 59 and 1/2 for both, and then we do a
withdrawal -- in the traditional IRA,
you have to pay taxes.
You're taxed ordinary income tax.
While in the Roth IRA, no taxes.
And we saw in the traditional IRA video, that this tends to
be pretty good.
When you're older than 59 and a half, you might be retired,
you might be in the lower tax bracket, so you're going to
pay the lower taxes on it.
And it's been differed for however many years your IRA
has been in existence.
Now this is especially interesting, because over here
you paid tax just on the original amount
that you put in.
And then you allow that original amount to grow over
many, many, many, years and that all of a sudden you're
not taxed at all.
So that all of a sudden becomes a little bit
This seems like a pretty good thing to have, and we're going
to actually play with the numbers to see
how they work out.
Now the other interesting thing about the Roth is if you
early withdrawal, for traditional a IRA you pay 10%
penalty on the withdrawal, plus you get taxed.
On the Roth IRA, if you're just taking the original
amount you put in-- and I'll do this with a numerical
example-- if you're just taking out your principal
amount, no taxes or penalty on the principal.
And you would only have to pay-- even if it's a
non-qualified withdrawl, and there's all these special
circumstances what's qualified and I'm not going to go to the
details-- you would only have to pay the 10% penalty and
taxes on earnings.
And one of the main reasons why I'm not going into all the
details is, one, it would make the video a little confusing.
But also, the government is constantly
changing the details.
So I want you to be able to watch these videos many years
in the future and it not to be dated, so I don't want to go
into all of the different things that the government is
changing from year to year.
But let's just do a very basic example just to get
the sense of things.
So let's look at a traditional IRA and then we have a Roth,
let me write IRA just to be clear that we're talking about
an IRA in both circumstances.
So let's say my original income amount, let's say I
made more than $5,000, I'll just use $5,000 thousand
dollars as my example.
And also make another note, Roth IRA is subject to more
limitations in terms of your total overall income.
And that's also changing, so I don't want to be specific on
You could look that up.
But there are ways that you can transfer traditional IRAs
into Roth IRAs, so that's kind of a little bit of a loophole
on being able to get around some of those restrictions.
But anyway, I won't go into the details just yet, but just
remember Roth IRAs there are some more limitations on
whether or not you can put things into it.
But if you're tricky, you might be able
to get around them.
So let's say you have $5,000.
And just so you know, the limits on IRAs-- they apply to
Roth or traditional or any combination of the two-- so if
you're starting with $5,000.
So in the traditional IRA, you have 0 taxes initially.
In your Roth IRA initially, let's say you have a 32% tax
bracket, just like in the previous video, then you'll
pay 32% on $5,000.
That's 0.32 times $5,000, that's $1,600.
So you're going to pay $1,600 in taxes.
So your amount in the account-- so in your account,
your principal in your traditional IRA-- maybe I
should write it out here-- starting with that $5,000,
your principal is going to be $5,000 here.
And it's going to only be-- you have to take
$1,600 out for taxes.
So it's only going to be $3,400 right there.
Now let's say in either situation, you were to take
that, invest it in some stocks, and then five years
later it doubles.
So let's say at some future point it doubles, and you sell
So that becomes $10,000 in your account there, and then
this you invested in stocks and it doubles.
This becomes $7,800 in your account right here.
So this is 10 years-- I think I said five
years into the future.
I'm just picking that into the future.
And let's say we're still not 59 and 1/2 years old just yet.
Now, we could just continue to leave either of these amounts
in our account until we're 59 and 1/2, but let's say we have
some type of need.
We need to give a loan to our brother-in-law or something,
so we really want to have access to this money.
So let's look at the situation where we withdraw.
If we were to withdraw-- well let's think of a couple of
situations-- if we were to withdraw $3,400.
Let's say that's exactly what my brother-in-law
needs, just right now.
So if we were to withdraw $3,400 in the traditional IRA
sense, so we take out $3,400.
We're going to have to do two things: First, we're going to
have to pay taxes on it, so we're going to have to pay 32%
of that, assuming we're still in the same tax bracket.
So $3,400 times 0.32 is equal to-- we're going to have to
pay $1,088 in taxes.
And we're also going to have to pay a penalty on this
entire amount, on the $3,400.
So we're also going to have to pay 10% penalty, $340 penalty.
So we're going to be left with, after paying all of
this, this is-- let me get the calculator out-- we're going
to be left with $3,400 minus $1,088 minus
$340 is equal to $1,972.
So we're left with $1,972.
Now in the Roth IRA, when you needed that money all of a
sudden and you decided to withdraw it early, and we're
only taking out $3,400.
So we're taking them out, the amount that was
our original principal.
In the Roth IRA, we get the $3,400, because that was our
original amount, and we pay no taxes or penalties.
So at any point in time on the Roth IRA, you can always take
your principal out.
In the other types of IRAs, not only will you have to pay
taxes on it, but you're also going to have to pay a penalty
on top of that.
So with the Roth IRA, one of the very positive things is,
it gives you a lot of flexibility.
Now, let's say you want needed to withdraw, I don't know,
let's say you needed to withdraw $4,000.
This is another scenario.
$4,000 at this same point in time.
In the traditional IRA scenario, once again you're
going to have to pay 32% of that in taxes, so you're going
to have to pay $4,000 times 32% in taxes and you're also
going to have to pay plus $400.
In the Roth IRA case, you pay nothing, you get the original
principal you put in, that was your original amount, $3,400.
In all of this, I'm assuming that we're not 59 and 1/2
years old just yet.
So in the Roth situation, you get the $3,400 free and clear,
tax and penalty free, but the other $600, you're going to
have to pay 32% taxes, or whatever your tax bracket is,
and then you're also going to have to pay $60, a 10% penalty
on just the earnings portion.
Remember, $3,400 was your principal.
Then if you want to take $4,000, the $600 extra, that's
stuff that you earned, that stuff that was
grown from the principal.
So you're going to have to pay plus another $60 penalty.
But it's still a much better situation, if you do the math,
then this one here.
So in general, if you're not sure whether you're going to
need that money before you retire, the Roth gives you a
lot more flexibility.
Now let's go all the way to retirement.
Let's say we never withdrew any money.
We invested in another stock, and so we go 10 years later.
So we never withdrew any money.
We're just going to look at the retirement situation.
And we go to our stock, and we sell it, our new stock.
We get $20,000 there.
Here we get $15,600.
And, of course, in both of these situations, it's great
that we're able to buy and sell stocks inside of these
retirement accounts and not pay taxes.
If these weren't sitting in retirement accounts, every
time we bought and sold the stocks, we would have to pay
capital gains tax.
And you saw that in the previous video.
Now that we are older, let's say we're 60 years old, we can
now withdraw our money from either situation.
There's some other little stipulations, your money has
to be seasoned, has to be sitting there for five years
and all that, but I won't go into the details.
But let's see what happens when we withdraw the money.
Let's say we have a 25% tax bracket now.
So we're a retiree, we're earning a little bit less
money, we are in a lower tax bracket.
In this situation, when we withdraw from a traditional
IRA, we are going to pay 25% in taxes, which is $5,000 in
taxes, and we are going to be left with $15,000 for
ourselves to spend in our retirement years.
In the Roth IRA situation, once we're over 60 years old,
our tax bracket doesn't matter, we just get the money.
$15,600 free and clear.
So if you think about it in either situation, when we
withdrew early, the Roth IRA was much more forgiving,
especially if we would draw less than the amount that we
originally put in, $3,400.
The Roth IRA does not tax us or give us penalties.
It only does that on any money that we earn, any money in
excess of the $3,400.
The traditional IRA taxes us and penalizes us on
And then even when we go into the future, remember, in the
traditional IRA, we didn't pay any taxes to begin with, but
we had to pay taxes to end with.
So when we pay taxes in the end, we're paying taxes not
just on what we put in initially, we're also paying
taxes on all of our cumulative earnings, right?
We originally put in $5,000, now we're
paying taxes on $20,000.
So we're only going to end up with $15,000.
While in the Roth IRA, we don't pay taxes on anything,
for, I guess, in return for being willing to pay our taxes
front-loaded, to pay them in the beginning, we never have
to pay taxes on that money or on any of the earnings that
that money makes.
Now, I fixed the numbers here to make them close, depending
on your tax bracket before and after, or how much growth you
actually see in your earnings, one may be better than the
other, but these are important considerations.
So I just want to let you know the pros and cons.
The Roth IRA tends to be better in terms of giving you
the flexibility and never not worrying to pay
taxes at the end.
And there's one other thing-- and this is, you know,
depending on how you view life, it might be a minor
thing-- in the traditional IRA, when you're 70 and a
half, they force withdrawal.
And then, of course, you have to start
paying taxes on things.
In a Roth IRA, there's no age limit.
So that's another consideration you might want
to take into.
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