Finance

BenFranklinEye

A Whole New World

So, I’m 22 years old right now and I recently have gained a lot of interest in personal finance. I grew up in a very money-conscious household. My mom was always saving for different things and trying to be prepared for anything that could happen. We weren’t rich, but my sister and I never missed out on anything due to a lack of money.

Up until August 2018, I was a spender. I didn’t have a plan. I wasn’t in credit card debt or anything, but I wasn’t saving or investing. Then, something happened and I’m not really sure how. I started watching some Dave Ramsey videos on YouTube. I had heard of Dave’s teachings before but never looked into them until this time. After hearing his opinions on saving and investing, I was energized. The thought of being a millionaire after I retire threw me through a loop. I couldn’t believe how easy the math seemed. Literally, just open a Roth IRA and fully fund it throughout your life and boom. Compounding interest is a remarkable thing.

Fast forward about a month and I’ve done a lot more research, asked a lot of questions, and made several moves. I’ve laid the groundwork for a successful future. I want to continue to learn more and grow each day.

CoinIncline

Live & Die by the Roth

I’ve gotten into this whole finance thing a little bit now, to say the least. I’m very interested in the subject and I love money. From my research in IRAs over the past couple months, I have one burning question that I haven’t been able to get a straight answer to: Why would anyone use a Traditional IRA over a Roth IRA?

Now, under certain circumstances, I’m sure there might be a reason to do so. However, I’m obviously most familiar with my personal situation, so I’m going to base a scenario off something in line with that.

The Scenario

I’ll use the same scenario to compare a Traditional IRA to a Roth IRA.

Start Age: 22
End Age: 67
Initial Amount: $0
Annual Deposit: $5,500
Average Return: 10%

Given these numbers, over 45 years my deposits would total $247,320 (6% of account total).

Those deposits would have made interest of $4,098,890 (94% of account total).

Add those two numbers together and we get the account total $4,346,210.

Let’s Do Some Math

Traditional IRA

In a Traditional IRA, you get a tax break on the contribution amount at the time you deposit it, but then you pay taxes on the account total when you withdraw later down the road. Basically meaning you save on taxes now, but then have to pay them later.

So, let’s fast forward to withdrawing time. Let’s take that account total from above $4,346,210 and assume the best case scenario given today’s tax brackets. We’ll say when I’m 67 I’ll be in the lowest tax bracket (10%), so that’s what I’ll have to pay in taxes.

$4,346,210 * .10 = $434,621

That gives a total of $434,621 that I will owe in taxes. Fair enough. Let’s see how the Roth IRA would differ.

Roth IRA

In a Roth IRA, you do not get a tax break on the contribution amount at the time you deposit it, but you also do not pay any taxes on the account total when you withdraw later down the road. Basically meaning you pay taxes now, but then you don’t have to pay them later.

Well, that’s pretty interesting, eh? I don’t have to pay taxes on all that interest, huh? Let’s look at the numbers.

Over that 45 year period, I deposited $247,320. I won’t be able to deduct those deposits from my income as I would be able to with a Traditional IRA, so let’s see how much I’d pay in taxes over that time. And to even give the Traditional a better chance at winning, let’s assume the worst case scenario given today’s tax brackets. We’ll say I’m in the highest tax bracket while I’m contributing (37%), so I’ll be getting hammered pretty hard in taxes.

$247,320 * .37 = $91,508

That gives a total of $91,508 that I will pay in taxes over the 45 year depositing period. Hmmmmm…

Comparison & Conclusion

Okay so, let me say that I don’t claim to be a financial advisor and I don’t know everything there is to know about the subject. However, I’m fairly confident that I have a pretty good idea of how the tax implications of these account types operate. If I am missing something, please please please let me know.

Having said that, why on Earth would anyone consider a Traditional IRA over a Roth IRA? In this very simple example, I would be ultimately be paying almost 5x more in taxes with a Traditional IRA. (And that’s actually the low-end given the tax bracket advantage I gave to help the Traditional IRA). It just seems unbelievable that anyone would make that decision.

In my search for an answer to this question, the only reasoning I found was “Base your decision on your tax bracket now compared to when you withdraw. (Higher now, go Traditional; Lower now, go Roth).” That makes sense in theory, but I don’t really agree with it in practice based on this example I came up with.

The only other thing I saw was a blog post about the optimal way to contribute. A method where you start in a Traditional and then slowly rollover into a Roth. I can understand how that might be the absolute best way, but, in that case, I’m not really sure if the headache of setting that up would be worth it in the end. I’d have to think of another scenario to do the math on that one.

 

Thanks for reading. Let me know your thoughts.

 

*Disclaimer: My opinions in this post are just that – my opinions. I do not manage investments for anyone other than myself and am not responsible for any losses you may incur due to financial posts I have published. Do more research and invest from an educated perspective.

Should I Withdraw My 401k and Invest It in Crypto

Should I Withdraw My 401(k) and Invest It in Crypto?

Someone asked me a great question today. Here’s a paraphrased version of it:

“I’m currently contributing to a 401(k) up to my employer’s max match. I’m 26 years old and my 401(k) has roughly a $10,000 balance. I feel like that could grow to $20,000-$30,000 by the time I’m 65, but I’m considering other options.

I’ve started to dabble in cryptocurrency investing. I feel that I could definitely take $10,000 and 2-5x it in BTC, ETH, and altcoins.

My question is would it make sense to withdraw most of, if not all, the $10,000, pay the 10% penalty, pay the income tax, and invest the funds into cryptocurrency?”

Interestingly enough, I’m actually in a similar situation. Here’s my thought process.

Let’s Break Down the 401(k)

As seen in this example, most employer-sponsored 401(k) programs offer an “employer match” of some sort. For example, a 401(k) program could offer to match 100% of your contributions each year, up to a maximum of 5% of your annual income.

Let’s say your salary is $50,000. If you contributed 5% of your pay ($2,500) to your 401(k), your employer would contribute an additional 5% ($2,500) to your 401(k) account balance. This “match” is sometimes referred to as “free money” because it’s rewarding you for investing. I did it when I had a 401(k), and I think it’s the smart play to only contribute up to the “max match”. Take the free money. After that, there are better ways to invest your money.

The biggest problem with 401(k) programs is that, unlike an IRA or Roth IRA, you are very limited as to which investment products you can invest in. My old 401(k) had about 30 pre-selected funds I could choose from, many of which only had average returns and high expense ratios (fees).

Use my Retirement Calculator

The next thing we need to look at is the expected returns in this example. With a current balance of $10,000 at 26 years old, $30,000 by 65 might be a bit of an underestimate.

Below is a screenshot of the calculation for this scenario. I used a very conservative annual interest rate of 5% and I even assumed that you never contribute any more money just to illustrate compound interest.

You can run this calculation for yourself using my Retirement Calculator.

I want to make a few key points from these numbers:

  • If left completely untouched and unadded to, that $10,000 is estimated to grow to over $73,000. You’d have to pay taxes when you withdraw it after retirement, but it would still be more than $30,000.
  • You’d probably add more to it and the annual interest rate would probably be more than 5%. So, this calculation is extremely conservative.
  • It’s impossible to say exactly what returns you’ll get over a 40 year period, but the stock market averages 8%-12%. Keep all of this in mind as we tackle the rest of this scenario.

Let’s Talk About Crypto

There is absolutely no way I’m going to provide a fair amount of information on the cryptocurrency market in this one blog post. As of writing this, I’ve been dabbling for about 5 months and I’ve barely scratched the surface. Do your due diligence before you jump in, but I’ll give my thoughts pertaining to this scenario.

Crypto is beginning to gain mainstream adoption, but the vast majority of people do not understand how it is going to change the entire world as we know it.

The total crypto market cap is $2 trillion. For reference, the market cap of the S&P 500 (the top 500 companies in the stock market) is $33 trillion. Crypto has a ways to go, but it also went from $1 trillion to $2 trillion in about 3 months…

I can’t predict the future. I’m simply sharing the numbers. There are over 10,000 cryptocurrencies. It’s not difficult to create one, so there are many duds out there. However, there are many coins, or projects, that actually serve a purpose and provide a utility of some sort.

Bitcoin (BTC), Ethereum (ETH), Binance Coin (BNB), Cardano (ADA), and Polkadot (DOT) are just a few of the top projects that have real value and multi-billion dollar market caps associated with them. With the value of USD deteriorating by the second, crypto is, at a minimum, worth exploring.

The main takeaway is that the crypto market is still very early and the long-term upside is unfathomable.

Managing Expectations

Could $10,000 invested in certain cryptocurrencies yield 200%-500% in returns? Absolutely, without a doubt. It happens quite often with low market cap coins as they gain traction.

The question is: can you make that happen and what’s the timeline?

The reason I bring this up is to manage expectations. From my experience thus far, the crypto market is a very volatile way to invest money. You have to be able to stomach that and also have realistic expectations.

Short-term, it can be rocky and your returns depend almost exclusively on how much time and energy you put into finding good projects. I know individuals that look at charts, research new coins, and swing trade 24/7. They do very well, but if that’s not what you want to be doing all day, prepare to buy and hold.

Long-term, nobody knows what will happen, but many signs point to incredible returns. As it relates to this scenario though, long-term growth might be what you’re looking for.

Withdrawal Implications

If you decide to withdraw from your 401(k) before the age of 59 1/2, there are some important details to consider.

The IRS is going to withhold 20% of the balance for taxes and you’ll pay a 10% penalty. So, you’re going to lose at least 30% of your money, potentially more depending on your tax bracket.

You will also want to make sure your employer allows full 401(k) withdrawals while still working for them. I’m not sure if that’s ever a real issue, but at minimum, you’d have to talk to your payroll department to make stop the weekly contributions.

Final Thoughts

Ultimately, I’m not a financial advisor and I can’t tell you what to do. The answer will depend on your personal risk tolerance and what your goals are.

More USD is being printed like it’s going out of style which should be somewhat of a concern. However, it’s all most of us have ever known and been the standard for a long time.

Crypto is early and some projects look promising, but the lack of regulation makes it the wild west right now. That’s good for some, bad for others. It shouldn’t be viewed as a get-rich-quick scheme and you’ll probably get burned if you treat it as such.

Regardless of what you do in life, do your due diligence and understand as much as possible before acting.

*Disclaimer: My opinions in this post are just that – my opinions. I do not manage investments for anyone other than myself and am not responsible for any losses you may incur due to financial posts I have published. Do further research and invest from an educated perspective.