mptfan wrote:redbeard, I don't know where to begin. You are so confused that you don't realize that you are confused.

Your examples are hoplelessly flawed and prove nothing.

This really doesn't help the discussion.

First, my scenario did NOT assume a higher marginal rate in retirement. I explicitly assumed that someone had the same income (50k) before and after retirement, and I explicitly assumed that the current tax rates apply and used 15% as the marginal tax rate in both cases.

You are right. I'm not sure why I had that wrong. What I should have said is if average rates matter in retirement, then one is clearly better off in that model using 100% traditional IRA, and if marginal rates are what count in retirement then adding some funds to a ROTH would be a wash (until the point where future marginal rates would be lowered by adding more). My numbers were intended to make the math simpler, but I'll show the scenario below using your tax rates to show that it really is a wash to add some ROTH (as marginal rates predict), and not a loss after taxes.

Second, in your example you assume a present marginal tax rate of 20%, and yet no such marginal tax rate exists. The current tax brackets are 0%, 10%, 15%, 25%, 28%, 33%, and 35%.

If the logic is right the prediction will work, regardless of whether the marginal rates assumed exist today or not. This is just a simple math problem. I chose the numbers I did to keep things simple. I'll use yours below to prove it doesn't change the fact that average rates don't assist in the decision making process.

Third, the annual rate of return on invested funds is irrelevant to this analysis. We are comparing the taxes saved while working to the taxes paid in retirement.

Agreed, but if I hadn't put that in someone would have said that was a problem with the model... You can replace the expected rate of return with any number and re run the numbers. The fundamental answer of which future tax rate (marginal or average) should be used for decision making won't change.

Fourth, you "assume" a future average tax rate of 15%, but you don't explain how you came up with this number. In my example, I showed exactly how I came up with the average tax rate of 8% in retirement, and you haven't disputed it.

Man, you are a tough grader! I assumed you understood this since you did the same calculation in your own scenario. Ok, I'll show my work!

Assuming $50k in IRA withdrawal, 0% marginal rate on the first $25K, 30% marginal rate on anything over $25k. 30% * ($50k - $25k) = 30% * $25k = $7,500. $7,500 / 50,000 = .15

As promised, here is the workup of the two period model using the tax details from your own model. If average rates in retirement are correct, 100% traditional IRA should be superior to using any amount of ROTH; the average rate of 8% in retirement is less than marginal rate of 15% in accumulation, while the marginal rates in accumulation and retirement are both 15%.

Keeping my two period model, separated by 20 years and an expected return of 10% annually. All tax assumptions from your model.

**Scenario 1: 100% IRA**
Initial investment of $7,432.18 into the IRA grows to $50,000 over 20 years at 10% growth rate.

Gross Income: 50k

Standard Deduction: 10.9k

Personal Exemptions: 7k

Taxable Income: $32,100 (you rounded this to $32k in your example)

Tax: $4,815 (you have this as $4,018, but I assume that is a typo)

Effective (Avg) tax rate: 9.63% (you have 8%, but we are close and this doesn't change the prediction of your model since it is still lower than current marginal tax rates of 15%)

Marginal Tax Rate: 15%

After tax Income during retirement: $50k - $4,815 = $45,185.00

**Scenario 2: 35.80% IRA 64.20% Roth***
Initial investment of $2,660.72 into the IRA grows to $17,900.00 over 20 years at 10% growth rate.

Initial investment of $4,055.74 into the Roth grows to $27,285.00 over 20 years at 10% growth rate. [$7,432.18- $2,660.72 =4771.46 pre tax available to the Roth. Subtract 15% of this ($715.72) for taxes paid and you get $4,055.74]

Gross Income: $17,900.00

Standard Deduction: 10.9k

Personal Exemptions: 7k

Taxable Income: 0

Tax: $0

Marginal Tax Rate: 15%

After tax Income during retirement: $17,900.00 + $27,285.00 = $45,185.00

* I picked 35.8% and 64.2% for the IRA and Roth respectively because this is the point where the future marginal tax rate changes to 0% (17,900 / 50,000 = 35.8%). If you put more in the IRA and less in the ROTH, the end results will be the same. If you do the opposite, you will be worse off after taxes.

The "decide using average future tax rates" argument predicts that moving some contributions to a ROTH in this case would make one worse off, while the "decide using future marginal tax rates" model predicts adding some ROTH will be a wash. As you can see, the correct prediction is made by using future marginal tax rates, not average ones.