Roth IRA vs Traditional IRA Vicente J Gonzaga

Roth IRA vs. Traditional IRA Vicente J. Gonzaga Erl Malboeuf Team 6

Overview �What are IRAs? �Roth vs. Traditional �The Scenario �Analyses and Comparisons �Conclusions

What are IRAs? �IRA = Investment Retirement Account Specialized savings accounts specifically geared for post-retirement funding �Tax features Tax-deductible Tax-deferred Tax -free

Choices, Choices �So why are we up here? �IRAs come in two main flavors: 1) Traditional 2) Roth �Which one?

Roth vs. Traditional �Traditional IRA Contributions are tax-deductible ▪ $75, 000 gross salary ▪ Deposit 10% ($7, 500) into a Traditional ▪ ($75, 000 -$7, 500)=$67, 500 (new gross income) �Cool beans, right?

Traditional IRA �Contributions are tax-deductible, but withdrawals are taxed based on the income bracket they fall under �Traditional IRAs Tax-deductible contributions Tax-deferred balance growth Taxed withdrawals/distributions

Roth IRA �Roth IRA Contributions are not tax deductible ▪ $75, 000 gross salary ▪ $75, 000 – [25%($75, 000)]=$56, 250 ▪ THEN deposit 10% ($5, 625) into the Roth IRA ▪ $5, 625<$7500 (from Traditional) �Ew… right?

Roth IRA �Contributions are made with after-tax dollars, but withdrawals are tax-free. �Roth IRA Contributions based on after-tax dollars Balance growth is tax-free Withdrawals/distributions are tax-free

Roth and Traditional �Important fact to keep in mind: Both Roth and Traditional IRAs impose contribution caps (equal for both) ▪ Caps are adjusted for inflation every few years. ▪ For simplicity, we treated cap adjustment as continuous These caps greatly affect the dynamics of the savings plan given initial conditions.

The Pitch �You are Yoda (you can live for a very, very long time). �You have used the force to earn an engineering degree and have landed a position with $60, 000 gross annual pay “Long, I live. ”

Major Assumptions �Deposits will always be a fixed percentage of available income �“Excess” savings (explained later) will go into market investment We later neglect “excess” �Assume no pension �Tax brackets always apply where appropriate

Default Values �Starting Gross Salary: $60, 000 �Expected Annual Raise=8% �Annual deposit rate: 10% Applies to available income Deposits between accounts are not equal This is strictly followed �Post-retirement Lifestyle: $65, 000 �Total years employed: 41

Default Values �Inflation: 3. 5% �IRA Caps increase by inflation (=3. 5%) �Interest earned on both IRAs: 5% �Market ROR: 9. 00% �Retirement Assets ROR: 6. 00%

The Reference Parameter? �Debt-free years after retirement! �How long under each account given equal conditions will you last after retirement?

Our Goal �UNPRECEDENTED , NEEDLESSLY METICULOUSL ACCURACY �(Flip to excel file and previous presentation on similar topic)

Assumptions Made (from a past class’ presentation) � Equal contributions to both plans � Roth IRA ineligibility ignored � Flat tax (not tiered) � Annual salary raises kept up with inflation at 3% � ROR is 10% � No 401 K matching from employer � No Social Security Benefits � No investment fees � 35 working years

Excess Included 200. 00 Years vs. EAR 180. 00 12. 0%, 175. 00 160. 00 140. 00 Years 120. 00 100. 00 Roth Traditional 80. 00 12. 0%, 73. 15 60. 00 40. 00 20. 00 0. 0% 2. 0% 4. 0% 6. 0% EAR 8. 0% 10. 0% 12. 0% 14. 0%

Excess Included 70. 00 Years vs. Deposit Rate 60. 00 50. 00 Years 40. 00 Roth Traditional 30. 00 20. 00 10. 00 0% 2% 4% 6% 8% Deposit Rate 10% 12% 14% 16%

Excess Included 70 Years vs. Salary 60 50 Years 40 Roth Traditional 30 20 10 0 0. 00 20000. 00 40000. 00 60000. 00 Starting Salary 80000. 00 100000. 00 120000. 00

Excess Included 30. 00 Years vs. Employed Years 25. 00 Years 20. 00 15. 00 Roth Traditional 10. 00 5. 00 0 5 10 15 20 25 Employed Years 30 35 40 45

So Far… �It looks like Traditional IRA is the better choice�But is the whole story? Remember that we’ve been including excess savings (that have been invested with an ROR of 9. 00%) �Let us now neglect excess savings

Excess Is Neglected! 6. 00 Years vs. EAR 5. 00 Years 4. 00 3. 00 Roth Traditional 2. 00 1. 00 0. 0% 2. 0% 4. 0% 6. 0% EAR 8. 0% 10. 0% 12. 0% 14. 0%

Excess Is Neglected! 6. 00 Years vs. Deposit Rate 5. 00 Years 4. 00 3. 00 Roth Traditional 2. 00 1. 00 0% 2% 4% 6% 8% Deposit Rate 10% 12% 14% 16%

Excess Is Neglected! 6 Years vs. Starting Salary 5 Years 4 3 Roth Traditional 2 1 0 0. 00 20000. 00 40000. 00 60000. 00 Starting Salary 80000. 00 100000. 00 120000. 00

Excess Is Neglected! 6. 00 Years vs. Years Employed 5. 00 Years 4. 00 3. 00 2. 00 1. 00 0 5 10 15 20 25 Years Employed 30 35 40 45

The Tables have Turned! �So what just happened? Excess Included => IRA wins Excess neglected => Roth wins �Which one really wins? The answer lies in the circumstances, and may change according to certain factors blahblah…

BASICALLY �It depends! �Traditional IRA “won” with excess This implies that the Traditional IRA allows for more flexibility with extra savings! �Roth IRA “won” when excess was neglected This implies that between the two, Roth IRA has the longest staying power based purely on account withdrawals!

The Bottom Line �The Roth IRA is the safer option for people who choose to invest extra savings minimally. If left to account balance alone, the Roth will outlast the Traditional. �People who tend to rely on earned interest and surefire, small investments should choose the Roth.

The Other Bottom Line �The Traditional IRA allows for creative use of large excess savings but does not have as much post-retirement staying power as the Roth. It is therefore slightly riskier. �People who are more confident investors and are investment-savvy may benefit more from a Traditional IRA, or may find the Traditional more appealing.