Comments on: A Tool for Comparing Roth vs Traditional IRAs

By: Susan Tiner

Susan Tiner — Wed, 25 Nov 2009 16:47:20 +0000

Hi Joel, thank you, and yes, I have thought of this, just haven’t had time to work on it.

By: Credit Card Chaser

Credit Card Chaser — Wed, 25 Nov 2009 05:19:05 +0000

Hi Susan,

Thanks for the nice compliment over on my guest article at LenPenzo.com! (http://lenpenzo.com/blog/id824-23-creative-and-sure-fire-ways-to-easily-earn-extra-money.html)

This is very cool that you have provided this Excel sheet for download! Have you considered maybe turning it into an online tool that people can use right on your website?

By: Carnival of Personal Finance #232 Thanksgiving Survival Edition

Carnival of Personal Finance #232 Thanksgiving Survival Edition — Mon, 23 Nov 2009 13:06:05 +0000

[...] Tiner from Brain Dead Simple! Financial Organizing presents A Tool for Comparing Roth vs Traditional IRAs, Oh how I love spreadsheets, Susan serves up a good one for you in very simple fashion as well as [...]

By: Susan Tiner

Susan Tiner — Fri, 20 Nov 2009 19:06:13 +0000

Hi Russell,

No, the tax-free earnings don’t automatically make the Roth a better deal.

Suppose PV is the present value of your savings, you put it in a traditional IRA and it grows for n years tax free at compounded interest i until withdrawal, at which point it’s taxed at Tn, the tax rate at withdrawal. Here’s what you get:

[(PV)(i)](1 – Tn) = (PV)(i) – (PV)(i)(Tn)

For example, if you invest $1 at 7% compounded annually for 20 years, that grows tax free to $3.87. Let’s say your tax rate Tn at withdrawal is 30%. So you get to keep $3.87(1 – .30) = $2.71.

In the case of the Roth you get:

[(PV)(1 – T0)](i) = [(PV) – (PV)(T0)](i) =
(PV)(i) – (PV)(i)(T0)

For example, let’s say you have $1 to invest, and the current tax rate T0 is 30%. Since you pay the tax up front, $1(1 – .30) = $0.70, you’re investing a smaller amount. Suppose this $0.70 grows tax free at 7% compounded annually for 20 years. You get $2.71, same as with the traditional IRA.

However, if the future tax rate Tn is higher than the current tax rate T0, the Roth will generate a higher return.

By: Russell

Russell — Fri, 20 Nov 2009 17:16:11 +0000

Maybe you can correct some confusion that I have with regard to the benefits of a Roth IRA. I understand the discussion of your tax rate with regard to funds that you are contributing to the Roth. Since in a regular IRA, you pay pre-tax dollars, up to a certain income limit, it makes sense to instead put them into a Roth if you believe that your Tax rate will be higher when you retire, thus saving you money on taxes by paying them up-front.
Where I am confused about the discussion is with regard to the earnings from a Roth. I would think that earnings would eventually make up the largest portion of the funds inside the Roth. Since they are tax-free if you leave money in the Roth for at least 5 years, doesn’t this automatically make it a better deal than any tax-deferred plan? I would think that regardless of your marginal tax rate, zero taxes on earnings is going to be a lower rate. Am I correct in this thinking, and if not, what am I missing?

Thanks!

By: Little House

Little House — Thu, 19 Nov 2009 14:57:14 +0000

I was just beginning to look into a Roth IRA for investment planning. I’ll have to check out your two articles and see if it still makes sense for me to do so.
thanks for the additional info!