How are Capital Gains treated in a Traditional IRA if one waits until age 59.5 (or later) to make withdrawls?

Question

Imagine two people starting starting with 2,000 pre-tax dollars to invest at age twenty-five. The tax rate is a constant 25 %, and the capital gains rate is constantly 15 %.One person invests in the ROTH IRA (for 1,500 dollars because of the tax), and one invests in the Traditional IRA. If the annual rate of return for each investor is 8%, who does better in the end if retirement is age 70, exactly 45 years later?

Answer 1

That's an interesting scenario. Using my retirement calculator, the traditional IRA would have the largest absolute value at retirement. But the annual payout would be the same either way. The specific amount varies depending on assumed life expectancy, but it stays the same for both IRAs.

Note that capital gains tax is irrelevant. The Roth payout is tax free and the traditional payout is taxed at ordinary income rates.

Answer 2

There is no special capital gains treatment of income within an IRA. All of the money is ordinary income in the year it's withdrawn. That doesn't change at 59-1/2 - the only thing that changes then is that you aren't subject to the 10% penalty for early withdrawal.

In your example, the person with the Roth would have less total money in his IRA after 45 years, but wouldn't pay taxes on withdrawals. Who was better off of the two would depend on how much was withdrawn, and the tax bracket of the person with the traditional IRA.

Answer 3

Roth 1500, 8% for 45 years, 47881
Trad 2000, 8% for 45 years, 63841, after taxed at 25% = 47880.75

but then there is capital gain. 47880.75 - 2000 = 45880.75 and taxed at 15%, so after taxed = 38998.64.

Roth gets 10882.6 more dollars. Am I correct?

Answer 4

it's treated as regular income (hopefully your income will be lower when you retire and are not working) and taxed at a lower rate