Contributing to the ROTH or IRA
Huck and Molly Finn from Hannibal, Missouri are both 30, earn $50K each, have a modest home, plan for one child in 2010, target to retire at 65, and expect to earn 3% real (after inflation) on their investments.
Their employers offer regular and Roth 401(k) retirement plans, but no match. Both plans can save taxes. Contributions to regular 401(k)s or IRAs are tax deductible, but withdrawals are taxable. Contributions to Roths aren’t deductible, but withdrawals are tax free.
If the Finns join neither plan, they can achieve, according to ESPlanner, a smooth annual living standard of $25,983 per person. If they each contribute annually to the regular 401(k) or to a regular IRA they can raise their living standard each and every year in the future by 10.40%. If they contribute even more, they’ll experience an even larger living standard hike after retirement, but they will have to reduce their current living standard.
If the Finns choose instead to contribute to a Roth 401(k) or to a Roth IRA, the most they can contribute annually without taking a current living standard cut is $4,360. Contributing at this level each year will raise their living standard, immediately and permanently, by 8.29%.
What If Taxes Rise By 30% When The Finns Start Their Withdrawals?
The regular 401(k) or IRA provides them an 11.27% gain. If they use the Roth 401(k) or IRA, they raise their living standard by 9.86%.
Though the regular 401(k) or IRA beats the Roth counterparts with or without the future tax hike, the difference in living standards between the two options is small—less than 2% with no tax hike and less than 1% with the tax hike.