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>Henry, did you run the numbers with equal out of pocket costs? If you
>just consider $2,000 to a Roth or deductible or non-deductible, the Roth
>will win. The goal is to get $2,000 into an IRA. The cost of doing that
>is different for the various types of IRAs. The true cost of the Roth is
>$2,000 to the IRA and $778 to the IRS. The true cost of the tax
>deductible IRA is $2,000 to the IRA and $778 to a taxable investment to
>make the out of pocket costs the same.

Yes, I took the tax savings for a deduction into account. I assumed that you would invest it in a vehicle which would provide the same rate of return and that the gains would be taxed as "ultra" long term capital gains (another 2% discount) instead of ordinary income. I ran it for several tax brackets (15%, 28%, 31%, etc.) and several scenerios (15% to 15%, 15% to 28%, 28% to 15%, etc.) and it would appear that the only downside for Roth investors is if they expect to be in a tax bracket that is 6% (or more) lower when they are withdrawing the monies.

But I did account for the tax savings slightly differently than you did though. While $2778 * 28% tax rate = $2000, you don't get to shelter $2778, you only get to shelter $2000 thus I only gave a $560 credit ($2000 income * 28% tax rate = $560) for the deduction. (Of course, if this is incorrect, I'll have to modify the spreadsheet and rerun the numbers. :-)

One thing that hasn't been discussed much but could have an impact on the Roth IRA is how the various states will handle it. If I recall correctly, none of the states have signed up to the Roth IRA concept yet so if you retire in a high tax state, those Roth returns might still be subject to a tax bite (albeit a smaller one).

>There is a case to be made for assuming a lower tax rate in retirement,
>even if you have the same income. When you are working and investing in
>the IRA, you are working with the marginal dollar and the marginal tax
>rate should be used. However, when you are retired, you will have income
>from several sources, the IRA being one source. Any of your sources of
>income could be considered the marginal dollar or any of the sources
>could be considered the first dollar. I think the average tax rate could
>be used for this time in life. Of course, if you cashed out the IRA or
>made a large withdrawal for a purchase, you would want to use the
>marginal tax rate.

There are so many scenerios that could be played out. Such as:

If one is presently in a high tax bracket, there is more room to drop to a lower tax bracket. But then again, if you are making that much money, you should then be saving that much more as well so the nest egg gets bigger faster and thus your distributions would be bigger since the nest egg is bigger.


If one is presently already in the lowest tax bracket, the only way you could drop any lower is not quality to pay any taxes whatsoever. So stuff that Roth IRA as full as you can!

This issue is, of course, something that everyone needs to decide on themselves. As for me, I hope to make decent money throughout my career and I expect to have the discipline to save a large portion of it and I have many years for the nest egg to build up so I fully expect to be among the highest tax brackets when I choose to retire.

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