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Interesting analysis. You are obviously an advocate of effective tax rates, but you missed a very key point that negates totally your comments about my use of marginal tax rates. Remember, I said:

<< John makes a tax-deductible contribution of $2,000 per year to a traditional IRA. He is considering the new Roth IRA, but must maintain the same net income he has today using the traditional IRA. John is in the 28% marginal tax bracket, which means he may only contribute $1,440 to a Roth IRA to keep his net income the same as it is by using the traditional IRA.>>

In your argument for using effective rates, you said:

<< John makes $40k per year, so his effective tax rate is 19.99%....if he put 2000 into a traditional IRA he would get $399.78 back in a tax refund.>>

Both statements are true. There's a big difference between what a person "makes" before taxes and what he "nets" after taxes. If John adds $2K to his current taxable income in my scenario, he will pay $560 in additional income tax for the privilege, not an effective $399.78 as you would have it. To keep a net income of $40K, he's got to pay taxes of $560 or his net income must drop. If his taxable income using the traditional IRA is $51,105, he nets $40K. If he foregoes the IRA deduction for the Roth, his taxable income jumps to $53,105. With the deductible IRA, he pays $11,105 in taxes. Without it, will his tax bill jump to $11,105 + $399.78 = $11,504.78 or to $11,105 + 560 = $11,665? The Tax Code says the latter. Therefore your effective rate is meaningless in the scenario I have outlined.

As to the imputed rate of return on the $560 foregone annual investment, you said:

<< I think the 8.244% return per year on the after tax account is bogus... here's my math:

return = (rate * 70%) ... taxed at capital gains rate + (rate * 30%) ... taxed at effect tax rate >>

I'm sure it makes sense to you to use effective tax rates here, but it doesn't to me. Again, the example has John in the 28% marginal rate. If the $560 per year earned a taxable dividend during the year, because of his marginal rate John would pay $0.28 on each dollar earned. You would have him pay something less based on the effective rate on his total income. To me, that's nonsense. After an individual has crossed the lower level of a tax bracket, each incremental dollar earned will be taxed at that bracket's rate and NOT the effective rate. The latter only has a bearing when overall income comes into play, not incremental income. In fact, each added dollar of income changes the overall effective tax rate. But until you cross into the next higher tax bracket, it doesn't change the marginal rate. Hence, I don't think my use of marginal rates in this computation is either "bogus" or inappropriate. But I do think your use of effective rates is. <g>

I'm still looking at the second part of your analysis, so I haven't a definitive comment to make on that. But I do have some clarifications as to why I took the approach I did. First, I avoided mention of age because I didn't want to get into the issue of minimum required distributions from the traditional IRA at age 70 ½. Instead, I wanted to present a generalized comparison as to growth after taxes. That's also why I treated the taxation of ultimate values on the traditional IRA as I did and ignored additional growth based on annual withdrawals. I was attempting to show the comparative effect of growth in the two accounts. Relatively speaking, a specific withdrawal pattern would not change the comparison. If both the Roth and traditional IRA continued compounding at the same rate, if a withdrawal was the same dollar amount from both accounts, and if the tax rates were as assumed, then the relationship of the accounts would be the same as that in the comparison I made for the "lump sums." Admittedly, that's not the best way to make the comparison, but it keeps things on even terms without a lot of mathematical gyrations.

I commend you on your work. You have shown (as I hope I have) that there's more to the Roth issue than first meets the eye. In fact, because Congress loves to tinker with taxes and will do more of that in the future, the time comparisons either of us make are based on assumptions that may be totally invalidated by this time next year. Therefore, any projection beyond five years is best taken with a grain of salt.

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