Chapter 14
Financial Planning Exercise 8
Deciding between traditional and Roth IRAs

Elijah James is in his early 30s and is thinking about opening an IRA. He can't decide whether to open a traditional/deductible IRA or a Roth IRA, so he turns to you for help.

1. To support your explanation, you decide torun some comparative numbers on the two types of accounts; for starters, use a 25-year period to show Elijah what contributions of $5,000 per year will amount to (after 25 years) if he can earn, say, 12 percent on his money.Round your answers to the nearest dollar.
   
   
   
   
   
   
   
   
   
   
   
   
   

   Traditional IRA	$
   Roth IRA	$

   
   
   Will the type of account he opens have any impact on this amount?
   -Select-YesNoItem 3
   Explain.
   
   
   
   


2. Assuming that Elijah is in the 25 percent tax bracket (and will remain there for the next 25 years), determine the annual and total (over 25 years) tax savings he'll enjoy from the $5,000-a-year contributions to his IRA. Contrast the (annual and total) tax savings he'd generate from a traditional IRA with those from a Roth IRA.If an answer is zero, enter "0". Round your answers to the nearest dollar.
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   

   Traditional IRA annual tax savings:	$
   Roth IRA annual tax savings:	$
   Traditional IRA total tax savings:	$
   Roth IRA total tax savings:	$

   
   




3. Now, fast-forward 25 years. Given the size of Elijah's account in 25 years (as computed in parta), assume that he takes it all out in one lump sum. If he's now in the 25% tax bracket, how much will he have, after taxes, with a traditional IRA as compared with a Roth IRA?Round your answers to the nearest dollar.
   
   
   
   
   
   
   
   
   
   
   

   Traditional IRA:	$
   Roth IRA:	$

   
   
   How do the taxes computed here compare with those computed in partb? Comment on your findings.
   
   
   
   


4. Based on the numbers you have computed as well as any other factors, what kind of IRA would you recommend to Elijah? Maximum allowable annual contributions to IRAs are $5,500 for 2016 for those under 50 and $6,500 for those over 50.
   -Select-Roth IRATraditional IRAItem 12
   Explain.
   
   
   Would knowing that maximum contributions are scheduled to increase to $7,000 per year make any difference in your analysis?
   -Select-YesNoItem 14
   Explain.
   
   

14-3Pension Plans and Retirement Programs

LO4,LO5Accompanying the expansion of the Social Security system has been a corresponding growth in employer-sponsored pension and retirement plans. In 1940, when the Social Security program was in its infancy, fewer than 25 percent of the workforce had the benefit of an employer-sponsored plan. Today, around 65 percent of all wage earners and salaried workers (in both the private and public sectors) are covered by some type of employer-sponsored retirement or profit-sharing plan.

In 1948, the National Labor Relations Board (NLRB) ruled that pensions and other types of insurance programs are legitimate subjects for collective bargaining. In response, many employers established new pension plans or liberalized the provisions of existing ones to meet or anticipate union demands. Qualified pension plans (discussed later in this section) allow firms to deduct for tax purposes their contributions to employee retirement programs. Even better, employees can exclude these contributions from their taxable income and can thus build up their own retirement funds on a tax-deferred basis.

Government red tape, however, has taken a toll on pension plans. In particular, theEmployee Retirement Income Security Act of 1974(sometimes referred to asERISAor thePension Reform Act), which was established to protect employees participating in private employer retirement plans, has actually led to a reduction in the number of new retirement plans started among firms, especially the smaller ones. Indeed, the percentage of workers covered by company-sponsored plans has fallen dramatically since the late 1970s. It’s estimated that today,in the private sector, less than 20 percent of all full-time workers are covered by company-financed plans—even worse, only about one-third (or less) of the part-time labor force is covered. In contrast,there has been a significant increase in defined contribution forms of retirementplans(discussed later in this chapter). In addition to ERISA, the widespread availability of Keogh plans, Roth, traditional, and SEP IRAs, and other programs have lessened the urgency for small firms (and bigger ones as well) to offer their own company-financed pension plans.