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tonyw44 Date: 3/31/99 3:08 PM Number: 9592
Well, think about it for a second. If you're in the 18 percent tax bracket, you need to come up with $2360 to put into a Roth IRA because you won't get the benefit of the tax deduction.

He would have to earn $2439 before taxes, and pay 18% of that in taxes to have $2000 to deposit in the Roth IRA.

So, if you do just $2000 and it's tax deductible, you're really only having to pony up $1640.

To keep the comparison on an even basis, you would have to earn $2000 before taxes to make this deposit.

That extra $360 is a real chunk of change for those in that tax bracket.

It's patronizing to assume someone can afford the first $2000 but not the next $439 based solely on their income. Individual circumstances vary greatly.

Let's suppose you are correct, and he can only afford $2000 of pre-tax income, and pick a scenario. Your plan is to invest it a few years, then convert it to a Roth IRA at a high tax rate. Say 5 years? Say 28%? What return on the investment - say 15%?

Deductible IRA, then Roth
$2000 * 1.15^5 * 0.72 = $2896 in Roth IRA

Straight Roth:

$2000 * 0.82 * 1.15^5 = $3299 in Roth IRA

Expressed like this, it's clear the only difference comes from the two tax factors, which then leads to the insight that as long as the limits aren't different it's best to go to Roth immediately so the contributions are taxed at the lower rate.

If he can afford to invest $2439 pretax dollars, the comparison is harder because the deductible IRA must invest the $439 in a taxable account. The taxable account could be used to pay the conversion tases, though. Let's assume the same 15% returns, all growth realized annually as long term capital gains and taxed at 10%. Each year $1 would grow to $1.15, then the 15 cents would be taxed 1.5 cents, leaving 1.135, so the after tax growth rate is 13.5%. So the deductible IRA then Roth has in a taxable account
$439*0.82*1.135^5=$678.

Before conversion, the traditional IRA has
$2000*1.15^5=$4023.
The conversion tax is 28% of this, or $1126.
So the Roth IRA will have 4023-1126+678=$3575

The straight, immediate Roth IRA will have
2439*.82*1.15^5=$4023

A careful study of the algebra (I hope I finally got this right - I changed many numbers as I proof-read this) shows the difference is that the taxable account grows more slowly and is taxed at a higher rate.
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