Jimmy wants to contribute either $5,500 (BT$) to a traditional deductible IRA, o

Question

Jimmy wants to contribute either $5,500 (BT$) to a traditional deductible IRA, or $5,500 (AT$) to a Roth IRA. His current tax rate is 30% for ordinary income and 20% for capital gains. He expects his IRA investment to earn a 12% before-tax rate of return (BTROR), and he plans to withdraw the IRA accumulation in 25 years, at which time he will be over age 59 ½. If he contributes to a deductible IRA, he will invest the tax savings from the deduction in a non-dividend paying stock that he expects to grow at a 12% BTROR. Jimmy will sell the stock at the same time he withdraws the IRA accumulation.

1) Compare the two alternatives assuming that, at the time of the withdrawal, Jimmy's tax rate will be 30%for ordinary income and 20% for capital gains.

2) Compare the two alternatives assuming that, at the time of the withdrawal,Jimmy's tax rate will be 15% for ordinary income and 10% for capital gains.

Prepare a spreadsheet showing the year-by-year accumulations for each investment in each circumstance; show your work.

Explanation / Answer

1)

Choose alternative Roth IRA as the final net withdrawl amount after tax is more for roth IRA as compared to  traditional deductible IRA.

2)

Choose alternative Roth IRA as the final net withdrawl amount after tax is more for roth IRA as compared to  traditional deductible IRA.

capital gain tax rate 20% (CGT) ordinary income tax rate 30% (IT) before-tax rate of return 12% (BTROR) Roth IRA Contribution 5500 Contribution(Aftertax) 3850 (=(1-IT)*Contribution) time Intital value of A/c Return on A/c End. value of A/c B(t-1) Rt=BTROR*B(t-1) B(t)=B(t-1)+Rt 1 3850.000 462.000 4312.000 2 4312.000 517.440 4829.440 3 4829.440 579.533 5408.973 4 5408.973 649.077 6058.050 5 6058.050 726.966 6785.015 6 6785.015 814.202 7599.217 7 7599.217 911.906 8511.123 8 8511.123 1021.335 9532.458 9 9532.458 1143.895 10676.353 10 10676.353 1281.162 11957.516 11 11957.516 1434.902 13392.417 12 13392.417 1607.090 14999.508 13 14999.508 1799.941 16799.448 14 16799.448 2015.934 18815.382 15 18815.382 2257.846 21073.228 16 21073.228 2528.787 23602.016 17 23602.016 2832.242 26434.257 18 26434.257 3172.111 29606.368 19 29606.368 3552.764 33159.133 20 33159.133 3979.096 37138.228 21 37138.228 4456.587 41594.816 22 41594.816 4991.378 46586.194 23 46586.194 5590.343 52176.537 24 52176.537 6261.184 58437.721 25 58437.721 7012.527 65450.248 at the time of the withdrawal value of A/c $                     65,450.25

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