Retirement Account vs. No Retirement Account

One of the things we really want to stress here at MomVesting is to make sure you're taking advantage of your tax-advantaged retirement plan options. If you're not, you're literally throwing money away. Let's take a look at the difference between using an IRA for your retirement savings and not using one.

Running the Numbers

Let's suppose that you have $4,000 left after expenses this year and you're going to invest it for 20 years. For the purposes of this experiment we'll use a 25% tax bracket and earnings of 5% per year. If we invest that $4,000 in an IRA, we don't have to pay any taxes on it, but if we put it in a regular account we do. So we're immediately at $3,000 in the regular account and $4,000 in the traditional IRA.

Over 20 years however, the numbers become even more stark. In the regular account, we have to pay taxes on our earnings every year, whereas in the IRA it grows tax-free. At the end of 20 years, we'd have $6,264.46 in the regular account and $10,613.19 in the IRA. Of course we'd now have to pay taxes on the IRA money when we withdraw it, but assuming the 25% tax bracket, we'd still have $7,959.89 left. Meaning if we use a regular account vs. an IRA in this case we'd be throwing away over $1,500 towards our retirement.

It Gets Even Better

Our assumptions above included two numbers that are actually very conservative. First of all, a 5% return is pretty low. Historically the stock market has returned 11%. If your money is growing at 10% per year in that example, the end account balances now become $12,743.55 and $20,182.50. We're now closing in on a difference of $10,000, and that's on an initial investment of only $4,000.

A second advantage of the IRA is that, more than likely, your tax bracket at retirement will be lower than while you're earning money. So if you're paying your taxes at the front-end as you are with the regular account, you're probably paying a higher percentage of taxes on your money with the regular account than you would with the IRA. Imagine the difference that could make on your final bottom dollar.

Maximize Your Returns

All of this is simply an example to make clear that you should be maximizing your retirement accounts before you do any other kind of investing. The only time this wouldn't be true would be if there was a good chance you'd need the money back in the near-term, since there's a penalty for withdrawing from an IRA. Otherwise you're just throwing money away.

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