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A lot of people are wondering why no two Roth IRA calculators on the Web give the same answer, and we wondered
the same thing at Money Insider. We discovered that there are three principal reasons:
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- The laws are incredibly complicated, forcing tough choices between precision and complexity.
- ItÆs difficult to do the calculations in a way that compares apples to apples.
- ThereÆs no way to get around making a whole bunch of assumptions about the long-term future, and itÆs
anybodyÆs guess as to which assumptions will be the correct ones.
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The only way to really understand the results from any Roth IRA calculator is to consider the assumptions and
trade-offs that were made in developing the calculator. With the advice of experts at the Big Six accounting firm Ernst
& Young, we made the following assumptions:
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- We assumed that Congress would make no significant changes to the laws governing the regular or Roth IRAs.
This oneÆs a whopper, but thereÆs not much to do about it. The biggest impact this has on the result is that we
assume maximum contributions to any type of IRA remain at $2,000 per person. If Congress changes the law
to increase contribution limits, it would allow much larger sums to be saved in these accounts.
- WeÆve provided two ways to pay the taxes on a rollover to a Roth IRA. One is from the rollover funds and the
other is from some other source of ready cash. If you pay the taxes from your rollover, thatÆs considered an
early withdrawal and results in a tax penalty that will almost certainly negate the tax advantages of the Roth. If
you choose not to roll over into a Roth, the funds that would have paid the taxes are assumed to continue
working for you in a taxable investment account. Many calculators donÆt take this "opportunity cost" into
account, which makes the Roth IRA look like a better deal than it really is.
- Most of the Roth IRA calculators on the Web present their results as an after-tax dollar amount that youÆll have
on the day you retire. From the traditional IRA, they subtract the taxes due in one lump sum at whatever you
say is your marginal rate. They simply show you what youÆll get at the end, but they never show you how much
youÆd receive if you used your IRA as a means of income over a period of years. We do. We present the lump
sum figure, but also let you compare the annual income you could expect from the two plans. Why? Because
your money keeps working for you and earning interest when you withdraw it over time. ItÆs a better way of
comparing apples to apples.
- We've included an inflation adjustment factor that tracks both your household income expectations and how it
would relate to the Roth IRA eligibility requirements as currently written. So if your income exceeds the
maximum amount allowed with the Roth, it automatically converts your contributions at that point to an after-tax
IRA. Similarly, we assume that if you aren't eligible for either a regular tax-deductible IRA or a Roth that you'll
contribute to an after-tax IRA.
- We assume that if you're going to roll your existing IRA into a Roth this year that you'll spread the tax
consequences over four years. This is the only year that you can spread the financial pain.
WeÆve assumed that if your income rises beyond the limits for a Roth IRA that youÆll do the rational thing and
make after-tax contributions to a regular IRA.
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One thing we chose not to do in this calculator, to keep things simple, is to adjust the distribution amount for inflation.
The annual income you would get in our calculation is a fixed dollar amount, and its value would erode over time, as
with any fixed-income annuity.
To see what the income from your IRA savings would be if you adjusted each year for inflation, try our Retirement
Income Calculator.
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