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Author: KATinChicagoland Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75340  
Subject: Re: Honest IRA/Roth Comparisons Date: 3/29/1998 11:37 PM
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<<I'm mystified about the Roth hubbub, but maybe I'm just missing the boat.

When I try to compare a traditional IRA to a Roth, the Roth ALWAYS comes out behind. That's because I insist on comparing apples to apples and equate a $2K pre-tax contribution to a traditional IRA with a $1440 Roth contribution (taking account of the fact that I will need to pay an additional $560 of taxes @28% on the now-taxable money). The Roth never recovers from this lower input, regardless of assumed investment returns or time horizons. The larger pie earns more money, and wins even though I have to pay taxes when withdrawing money...there's more than 28% more money at the end.
Comparing the returns on $2K contributions to both plans just isn't honest (and therefore not Foolish).
So, other than inheritance differences, why should I even consider a Roth?>>

This message generated some interesting responses, but none of them squarely hit what I thought were the two most important things to be said here, so here's my 2 cents.

First, there's something wrong with your math if you provide the same return to these two "equivalent" IRAs and the regular IRA ends up with more than 28% more money at the end. Take $2,000 and give it whatever return you like for whatever period you like, compounding as you go. Do the same for $1,440 and you will end up with a dollar amount that is 28% less. Exactly. So if you assume 28% up and down the line, and compare the $2,000 regular IRA to the $1,440 Roth IRA, you come out with the same number of dollars in your pocket after paying the taxes. The Roth IRA doesn't lose, it ties. As it happens, I use this exact example on my web site, at:

http://www.fairmark.com/IRAs/Roth/taxfeat.htm

But the more important point is one that you almost have your finger on, but haven't recognized: If you do in fact fund the Roth IRA to the full $2,000, you have, in effect, a larger IRA. If a $1,440 Roth IRA is the true equivalent of a $2,000 deductible IRA, then what would be the equivalent of a $2,000 Roth IRA? Answer: a $2,778 deductible IRA! That's a 38% increase in the amount of money that is receiving the benefit of tax-free compounding.

Now you obviously don't receive this benefit if you only put $1,440 in your Roth IRA. But if you want to do a thorough and honest comparison, try this: compare the result of putting $2,000 per year in a Roth IRA with the result of putting (a) $2,000 per year in a deductible IRA and (b) $560 per year in a taxable (non-IRA) investment account. I think Top Cat makes a good point when he says people generally don't shoot that $560 of tax benefit into savings, but my point is that the Roth comes out way ahead over the long run even if they do.

The Roth IRA is BIGGER. That's what makes it so powerful. That doesn't mean it's for everyone, and I'm careful to point out reasons NOT to use a Roth IRA on my web site. But if you think the best way to compare the Roth IRA with a deductible IRA is to shrink the Roth down to $1,440, then you truly are missing the boat. The extra $560 is the engine that pulls the Roth IRA out ahead.

KAT in Chicagoland
http://www.fairmark.com
Tax Guide for Investors
Now with expanded and revised
Roth IRA information

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