Initial decrease in consumption constant

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Suppose you are a thirty-year-old worker choosing between an IRA, a ROTH IRA and a regular brokerage account. Your marginal federal tax rate is 15% now and 15% in retirement. Your investment of $1000 of reduction of current consumption will earn before tax return of 7% for 35 years (note, this means that you invest approximately$1176=$1000/(1-.15) for a regular IRA, getting back $176 as reduced taxes, in the first example, while you invest $1000 for the other two types of accounts). The tax on investment returns on a regular brokerage account is 10% (meaning you earn a 6.3%after tax annual yield).

a) Compare after-tax returns on all three forms of investment. Rank the investment options.

b) Suppose your tax rates are 30% now and 15% in retirement: what is the best option now? Please be sure to keep the initial decrease in consumption (after-tax income) constant.

c) What if the rates are 15% now and 30% in retirement?

d) Suppose the marginal tax rate now is 15%. What would future marginal tax rate have to be for a regular brokerage account to be a better option than a regular IRA?

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Reference no: EM13859537

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