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Subject:  Re: Roth Beware-Substantial Savings Date:  1/13/1998  5:46 PM
Author:  rickisme Number:  1259 of 88513

bellgarde wrote: Hello there - it's Tuesday!. Any chance that you'll be able to post the numbers. Certainly like to see them, perhaps even some of your guesstimates on tax rates in future years.

I did run some numbers and I also visited some of the web sites that have these Roth calculators. I found some of them not to be reliable on the calculations, although some were. A mixed bag. One needs to be careful. Keep in mind that the assumptions that I am making and for this scenario to play out as I outline, must actually occur exactly as outlined. Of course no one really knows how Roth will fare in a few years, nor does anyone know whether tax rates will be lower (the basis of my assumption). Although I have not finished all my research in this area, this is one specific possible outcome (of infinitely many) of Roth and the results astound me. I double checked the number crunching but am open to criticism if I'm in error.

OK, Fanny Fool makes $50,000 TAXABLE INCOME before her IRA contribution. She is in say the 28% (could be higher but will use arbitrarily) tax bracket. She is 30 years old and wants to retire by 60. Now the tax on $50,000 @ 28% is $14,000. If she contributes to Roth, that's the tax she will pay. If she contributes to a regular IRA, she will owe $13,440 ($50,000 less the $2,000 IRA decuction times 28%), for a savings of $560 per year on her tax return. Now, many of the calculations and comparisons out there do not assume that Fanny will take that $560 and reinvest it. I do! So, if we go to the compound interest tables to the future value of an annuity (sum of equal payments) and assume one can earn 12% for 30 years, there are two amounts to consider:

1. The $2,000, which will accumulate to $482,665.36 in 30 years at 12%,

2. The $560, which will accumulate to $135,146.30 in 30 years at 12% compounded.

Now assume also that Fanny Fool will expect to live until she is 80, or 20 more years. Just looking at the Roth accumulation at retirement of $482,665.36, if we say how much can she withdraw each year (using ordinary annuity on all examples), we go to the Present Value (PV) tables at 12%, for 20 years and divide the amount by the factor, and we see that she will have $64,618.68 each year available tax free for 20 years and then she will run out completly.
Exuse me for explaining if you already know this, but the calculation is: Take the $482,665.36 and add a 12% return each year but subtract $64,618.68 also. Keep repeating this and the balance declines over time to zero. It increases by the return but decreases to a larger extent each year by the withdrawal.

Now, if Fanny Fool decides to go with the regular IRA under these(and these only!) assumptions, she will have accumulated upon retirement the sum of the $482,665.36(same $2,000 as under Roth) PLUS the future value of the $560 savings each year- total of $135,146.3, for a total at retirement of $617,811.66. Now, assume two possible tax brackets on which she would have to pay taxes: 15%(likely) and 28%(also likely). For her to have the same amount of yearly income ($64,618.68) as under Roth, she would have to withdraw a before tax amount each year of $76,021.98 for the 15% bracket and $89,748.17 for the 28% bracket. The amount after taxes of 15%&28% would equal $64,618.68. So, for the 15% bracket assumption using the same procedure of first adding 12% on the $617,811.66 and then subtracting $76,021.98 each year, the balance will decline to zero NOT in 20 years but in just over 32 years. The balance available in 21st year is an astounding $463,843.27, not zero as under Roth. Now if Fanny were to have a 28% tax bracket upon retirement, she would run out of money under the regular IRA in the 16th year, when she was 76. Of course none of this includes Social Security or any other assistance from the government. Results: If and only if one pays taxes in the 28% bracket for 30 years and upon retirement only pays 15%, the savings under the regular IRA are substantial; however, if the tax bracket upon retirement is the same or higher, Roth provides the greatest savings.

Sorry for the long post, but I am a hopeless teacher.

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