Question

Chapter 14
Financial Planning Exercise 12
Deciding between traditional and Roth IRAs

Clint Crandall is in his early 30s and is thinking about opening an IRA. He can't decide whether to open a traditional/deductible IRA or a Roth IRA, so he turns to you for help.

To support your explanation, you decide to run some comparative numbers on the two types of accounts; for starters, use a 30-year period to show Clint what contributions of $5,000 per year will amount to (after 30 years) given that he can earn, say, 10% on his money. Round your answers to the nearest dollar.

Traditional IRA	$ _____________
Roth IRA	$ _____________

Answer 1

In traditional IRA, there are tax benefits associated with investments but at maturity, you need to pay taxes. On the other hand, in Roth IRA, there are no benefits associated with investments but redemption at maturity is tax free.

Assume that Clint has 30% tax rate. Future value of contribution can be calculated using FV function

With Tradititional IRA: N = 30, I/Y = 10%, PMT = 5,000, PV = 0 => Compute FV = $822,470.11

After taxes, he would have $822,470.11 x (1 - 30%) = $575,729.08

With Roth IRA: N = 30, I/Y = 10%, PMT = 5000 x (1 - 30%), PV = 0 => Compute FV = $575,729.08, which is exactly equal to traditional IRA.

Hence, in both cases, he would have the same amount.