Difference between Roth IRA and traditional IRA

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Reference no: EM131983293

The difference between a Roth IRA and a traditional IRA is that in a Roth IRA taxes are paid on the income that is contributed but the withdrawals at retirement are tax-free. In a traditional IRA, however, the contributions reduce your taxable income, but the withdrawals at retirement are taxable. Assume you plan to devote $5,000 to retirement savings in each year. You will retire in 30 years and expect to live for an additional 20 years after retirement.

a. Assume the before-tax interest rate is 5%. What will be your after-tax 20-year retirement consumption stream if you choose to save in a traditional IRA? Assume your tax rate is fixed at 30%.

b. What will be your 20-year retirement consumption stream if you choose to save in a Roth IRA?

c. Which provides better expected results if you expect your tax rate to decrease from 30% today to 25% at retirement?

Traditional IRA

Roth IRA

Reference no: EM131983293

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