Question

One of the simplest tax avoidance strategies is to contribute to a Roth IRA, although this may not be right for everyone. Some individuals, particularly low-income households that may be eligible for tax credits because of young children in the home, may benefit more from contributions to a traditional IRA. Here, you want to help Debra identify the best retirement savings option for her situation.

Debra is 25, single, and makes $42,000 a year. Debra does not have access to an employer-sponsored retirement plan, but she really wants to start saving for retirement. She can contribute $5,600 of pretax money to a traditional IRA, or she can contribute $4,760 of after-tax money to a Roth IRA. The $840 difference represents the tax that Debra has to pay. Assume Debra continues to make this same annual contribution for 30 years and earns 8% on her investment.

Use the time value of money (TVM) formulas to calculate what the future value will be and how much she will have after taxes are paid in retirement by completing the following table. (Round answers to nearest whole number)

		Traditional IRA		Roth IRA
Money available to save		$5,600		$5,600
Tax on money available to save		$0		$840
Net annual contributions		$5,600		$4,760
Number of years contributions are made		30		30
Future value at 8%		$		$
Retirement tax rate		23%		0%, Qualified Roth IRA distributions are tax free.
Tax		$		$
After-tax wealth		$		$

Answer 1

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