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Quantifying the Benefits of a ROTH Account

Many investors have questions about the relative merits of ROTH accounts compared to traditional retirement savings plans, such as 401k plans and individual retirement accounts.  When advisors are asked which type of savings vehicle is best, the answer is usually "it depends."  And indeed it does depend --- on the account holder's time horizon, their current level of pre-tax and taxable savings, their current marginal tax rate, the future expected marginal tax rate, and their long-term expected portfolio rate of return, to name a few of the important factors. 

The intuition that most investors and many advisors have about ROTH accounts --- that the decision to choose a ROTH instead of tax-deferred accounts is fundamentally a decision about tax rates ---- is flawed.  While the tax rate is one important factor, it is not necessarily the most important factor.  The large number of variables and wide range of possible outcomes makes the question of how to evaluate ROTH accounts ideally suited for scenario analysis.  Modeling a scenario requires some assumptions about the variables, but then the outcomes can be estimated and evaluated. 

We began to seriously evaluate ROTH accounts in 2009, in anticipation of the change in tax law in 2010 that permitted ROTH conversion for taxpayers in all income tax brackets.  The next year, we decided that we needed an analytical tool to illustrate some of the recommendations we were making at the time.  This tool evolved into a web-based model, accessible here, that can be used by self-directed investors who are interested in this topic.  If you have feedback or questions about the model, the assumptions, or the results, please feel free to contact us.

A screen shot of the Roth Conversion Calculator
Access the Model


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Comment   |  8 years ago from San Francisco, CA