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# Traditional IRA vs Roth IRA

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Suppose one of your clients is four years away from retirement and has only \$2,500 in pretax income to devote to either Roth or traditional IRA. The traditional IRA permits investors to contribute the full \$2,500 since contributions to these accounts are tax-deductible, but they must pay taxes on all future distributions. In contrast, contributions to a Roth IRA are no tax-deductible. For example, if a person's tax rate is 25 percent, an investor is able to contribute only \$1875 after taxes; however, the earnings of a Roth IRA grow tax free. Your company has decided to waive the one time set up fee of \$50 to open a Roth IRA; however, investors opening traditional IRA must pay the \$50 set up fee. Assuming that your client anticipates that her tax rate will remain at 19 percent in retirement and will earn stable 7 percent return on her investment, will she prefer a traditional or Roth IRA?

#### Solution Preview

Tax savings for \$2500 contribution today: 2500 x 25% = \$625
Fee for setup of IRA = \$50
Tax cost when withdrawn: \$2500 x 19% = \$475
Tax on earnings at 7% compounded annually for 5 full years is \$1006 x 19% = \$191
Total tax is \$475 + \$191 = \$666

Roth IRA
Tax cost for \$2500 to a Roth rather than a traditional IRA: 2500 x 25% = \$625
Fee for setup of Roth = \$0
Tax savings when withdrawn: \$0
Tax on earnings = \$0

Variable factors that could influence the decision:
1. Traditional IRAs are subject to the RMD (required minimum ...

#### Solution Summary

The traditional IRA versus Roth IRA are examined. The investors for opening traditional IRA are provided. The clients anticipated are given.

\$2.19