Because investments are not all taxed at the same rates, it makes a very significant difference in IRA tax depending on which investments you choose to hold inside and outside your IRA. I have covered this in some detail at my blog post on income tax rates.
I this post, I show an example of an individual with $200,000 inside an IRA and another $200,000 of investment outside of the IRA. In the first case below, the individual has correctly placed his aggressive trading stocks in his IRA and holds his index mutual funds outside his IRA. His total tax over 20 years (assuming he withdraws everything from his IRA after 20 years) is $408,744.
But under scenario 2, the individual puts the wrong investment into the IRA (index mutual funds) and trades aggressively with stocks outside of his IRA. He owns the exact same investments over the 20 year period but in scenario 2, because he holds the investments in the wrong accounts, he pays an additional $117,000 in taxes.
|IRA Tax Scenario 1||Outside IRA||Inside IRA|
|$200,000 index mutual funds||$200,000 aggressively traded stocks|
|dividends at 3% annually||$6,000|
|long term capital gains at 5% annually||$10,000|
|Year 1 tax (15% x $16,000)||$2,560||all deferred|
|Total tax paid over 20 years||$117,150|
|Balance in year 20 ($911,232), taxed at 32%||$291,594|
|total tax $408744|
|IRA Tax Scenario 2||Inside IRA||Outside IRA|
|$200,000 aggressively traded stocks||$200,000 index mutual funds|
|Year 1 tax (32% x $16,000)||all deferred||$5,120|
|Total Paid after 20 years||$234,301|
|Paid on IRA balance in year 20 ($911,232), taxed at 32%||$291,594|
|total tax $525,895|
Unfortunately, few individual taxpayers will realize this error. More despairingly, the average financial advisor has never given this issue a thought and your CPA has never asked to see what investments you hold in your IRA. Accountants seem to be much more focused on simply getting the details on what has already happened onto your tax return than on providing strategies to reduce your IRA tax and lower your overall income tax rates.