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A Roth IRA enables an individual to invest after-tax dollars during the accumulation phase of a retirement plan. The money is then income tax free when it is withdrawn during retirement. A tax-deductible IRA, on the other hand, provides an up-front tax deduction for the annual contribution, but it then requires income taxes to be paid on all future distributions. A basic assumption as to which plan is more beneficial concerns the current value income tax rates versus their projected rates in the future. Suppose that you plan to invest $4,000 at the end of each year for 30 years. Your current income tax rate now is 28%, so $4,000*(1-0.28) = $2,880 can be invested this year into the Roth IRA. However, the full $4,000 per year can be invested into a tax-deductible IRA. Money invested under either plan will be deposited into a mutual fund earning 8% per year. (A) Develop a spreadsheet to determine which IRA will be the better investment. (B) Assuming you will turn 65 in 30 years, examine your projected income and tax rate and develop an investment and retirement withdrawal strategy.

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Hubert Koch
Hubert KochLv2
28 Sep 2019

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Yuki (age 45 at year-end) has been contributing to a traditional IRA for years (all deductible contributions), and her IRA is now worth $38,000. She is trying to decide whether she should roll over her traditional IRA into a Roth IRA. Her current marginal tax rate is 25 percent. She plans to withdraw the entire balance of the account in 20 years and she expects to earn a before-tax rate of return of 4.8 percent on her retirement accounts and a 3.8 percent after-tax rate of return on all investments outside of her retirement accounts. For each of the following alternative scenarios, indicate how much more or less Yuki will accumulate after taxes in 20 years if she rolls over her traditional IRA into a Roth IRA. Be sure to include the opportunity cost of having to pay taxes on the rollover. (Round "Future value factor" to 4 decimal places. Round final answers to the nearest whole dollar amount.)

a. When she withdraws the retirement funds in 20 years, she expects her marginal tax rate to be 35 percent.

b. When she withdraws the retirement funds in 20 years, she expects her marginal tax rate to be 20 percent.

c. Assume the same facts as in part (b), except that she earns a 2.8 percent after-tax rate of return on investments outside of the retirement accounts.

Bob and Lisa are both married, working adults. They both plan for retirement and consider the $2,000 annual contribution a must. First, consider Lisa’s savings. She began working at age 20 and began making an annual contribution of $2,000 at the end of the year beginning with her first year. She makes 13 contributions. She worked until she was 32 and then left full time work to have children and be a stay at home mom. She left her IRA invested and plans to begin drawing from her IRA when she is 65. Bob started his IRA at age 32. The first 12 years of his working career, he used his discretionary income to buy a home, upgrade the family cars, take vacations, and pursue his golfing hobby. At age 32, he made his first $2,000 contribution to an IRA, and contributed $2,000 every year at the end of the year up until age 65, a total of 33 years / contributions. He plans to retire at age 65 and make withdrawals from his IRA. Both IRA accounts grow at a 7% annual rate. Do not consider any tax effect. Write a two to three (2-3) paragraph summary in which you: Create a chart summarizing the details of the investment for both Bob and Lisa. Explain the results in terms of time value of money.

Complete the following homework scenario:

Bob and Lisa are both married, working adults. They both plan for retirement and consider the $2,000 annual contribution a must.

First, consider Lisa’s savings. She began working at age 20 and began making an annual contribution of $2,000 at the first of the year beginning with her first year. She makes 13 contributions. She worked until she was 32 and then left full time work to have children and be a stay at home mom. She left her IRA invested and plans to begin drawing from her IRA when she is 65.

Bob started his IRA at age 32. The first 12 years of his working career, he used his discretionary income to buy a home, upgrade the family cars, take vacations, and pursue his golfing hobby. At age 32, he made his first $2,000 contribution to an IRA, and contributed $2,000 every year up until age 65, a total of 33 years / contributions. He plans to retire at age 65 and make withdrawals from his IRA.

Both IRA accounts grow at a 7% annual rate. Do not consider any tax effects.

Write a two to three (2-3) paragraph summary in which you:
Create a chart summarizing the details of the investment for both Bob and Lisa.

Explain the results in terms of time value of money.

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