Assumptions for Figure 3.5: Roth IRA Savings vs. Traditional IRA Savings

  • Contributions to a Roth IRA are made in the amount of $7,000 per year, beginning in 2022, for a 55-year-old investor, for 11 years until he reaches age 65.
  • Contributions to a regular deductible IRA are made in the amount of $7,000 per year by a different 55-year-old investor, for 11 years until he reaches age 65. This investor’s IRA contribution creates an income tax deduction for him of 24 percent, or $1,680. I will give the best-case scenario and say that this investor did not spend his tax savings. Instead, he invested his tax savings into his after-tax investment account and did not spend it.
  • The investment rates of return on the Traditional IRA, the Roth IRA and the after-tax investment accounts are all 6 percent per year.
  • For the after-tax monies, the rate of return includes 70 percent capital appreciation, a 15 percent portfolio turnover rate (such that much of the appreciation is not immediately taxed), 15 percent dividends, and 15 percent ordinary interest income.
  • Ordinary income tax rates are 24 percent for all years.
  • Tax rates on realized capital gains are 15 percent.
  • Beginning at age 72, the RMDs from the Traditional IRA are reinvested into the after-tax savings account.
  • The balances reflected in the figures reflect spending power, which is net of an income tax allowance of 24 percent on the remaining Traditional IRA balance. If the full amount was actually withdrawn in one year, however, the tax bracket may be even higher and make the Roth IRA appear more favorable.