I have written before about my concerns with Roth and the possible effects on future wealth IF we go to a flat tax in the future or something like a flat tax with lower rates. Has anyone done any number crunching on this? I don't think it is unreasonable to assume that we may have a flat tax or even a flatter tax in the future. I think it is more likely than not. Now, I did some quick calculations by hand and made some assumptions and unless I punched the wrong buttons on my hand calculator, I was amazed at how much can be lost in wealth by choosing Roth vs Regular IRA, that is IF there is a flat tax in the future lower than the current rate (in my example). I need to go over my assumptions and calculations - at first glance it seems that I might have made a mistake somewhere given the SUBSTANTIAL savings one could obtain by remaining in a regular IRA vs Roth given the assumption of a future tax reduction and I apologize in advance for any such mistakes I may have made. If anyone is interested, when I finish my math recalculations, I'd be happy to post. Oh well, have to run, my teenage daughter needs to use the phone.

rickisme

Rickisme,

<< If anyone is interested, when I finish my math recalculations, I'd be happy to post. Oh well, have to run, my teenage daughter needs to use the phone.>>

I'm always interested. When you do post, tell us the assumptions you used, too. That is do so if you can get a phone line for the modem. :-)

Regards.....Pixy

Pixy:

I did rerun the numbers and have contacted publisher for writing an article on that and other aspects of Roth vs Regular. When I get a confirmation (Monday??) about it, I'll then give you the numbers. Thanks,

rickisme

<

I did rerun the numbers and have contacted publisher for writing an article on that and other aspects of Roth vs Regular. When I get a confirmation (Monday??) about it, I'll then give you the numbers. Thanks,

rickisme>

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.

Regards Bellgarde

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.


rickisme

Rickisme,

<<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>>

I didn't check your math, but it looks o.k. from the explanation. Just two comments: First, there's really nothing new or shocking with your conclusion. It's been published in several articles and analyses already. Second, you don't mention the mandatory withdrawal from the regular IRA starting at age 70 ½. It must be taken and will be taxed. The result here would be to push good ole Fanny into a higher bracket probably and would have an impact on her remaining stash.

Overall, though, it's a good effort. I wish you luck with the article. And BTW, you should really take the time to verify the break points for marginal brackets before your publish. Anticipate and forestall the criticisms before they occur. J

Regards……Pixy

Rickisme,

<<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>>

I didn't check your math, but it looks o.k. from the explanation. Just two comments: First, there's really nothing new or shocking with your conclusion. It's been published in several articles and analyses already. Second, you don't mention the mandatory withdrawal from the regular IRA starting at age 70 ½. It must be taken and will be taxed. The result here would be to push good ole Fanny into a higher bracket probably and would have an impact on her remaining stash.

Overall, though, it's a good effort. I wish you luck with the article. And BTW, you should really take the time to verify the break points for marginal brackets before your publish. Anticipate and forestall the criticisms before they occur. :-)

Regards……Pixy

Pixy:

You are correct. I should have included what you mentioned for a complete analysis of the whole picture. Thanks,

rickisme

As Pixy said, the Required Minimum Distributions would have probably changed the calculations. If you would like to run the numbers from my example and look up the figures in the tables, etc. and/or just learn something about RMD, look here: http://www.vanguard.com/educ/retire4/r4_4.html



rickisme

>>>Now, many of the calculations and comparisons out there do not assume that Fanny will take that $560 and reinvest it. I do!<<<

rickisme,

Did you assume the $560 would compound tax-free? If so, why?

Orangeblood

Don't forget that Fanny's IRA contributions won't be fully deductible until 2005. That changes the amount in the "side" account, and also changes the amounts to
be taxed on at withdrawl.

Also don't forget that for people whose AGI exceeds the deduction limit ($100k for couples and $60k for individuals in 2007), the Roth is probably the better way to go, since they don't get to accumulate anything in the "side" account.

Bill

Orangeblood wrote: "Did you assume the $560 would compound tax-free? If so, why?"

Very good question Orangeblood. Even though the $560 is the savings each year on income already taxed that one would get from contributing $2,000 each year, that money cannot be placed in the IRA tax free because $2,000 is the maximum per year contribution. So, assuming one could not either increase the amount of say a 401K contribution by $560, or if one could not invest the $560 in a nontaxable municipal that would yield 12% (not likely possibly), then yes, the $560 would be taxed at 28%. In my example, I did not consider ALL (probably should have) of the possible ramifications of what might happen, it was presented as a simple (not possible with taxes) example (in rough draft stage of completion) of one possible difference between Roth and Regular IRA. Thanks for your astute question.

rickisme

Fenner: My example did not address any other IRA limits, etc. See my note to orangeblood. Thanks,

rickisme