Kate can invest $4,000 of after-tax dollars (AT$)directly in a taxable bond outside an IRA, or she can contribute the $4,000 to a nondeductible IRA and invest in the same bond through the IRA vehicle. In either case the bond yields an annual 3% before-tax rate of return (BTROR). Kate's marginal tax rate is 15%, and she expects it to remain so for the entire investment horizon of 25 years. What is the after-tax accumulation for the "bond outside the IRA" after 25 years?

Question

Quizplus · Accepted Answer

Investing outside the IRA:
Kate invests $4,000.
After-tax annual rate of return = (1 - 0.15) × 3% = 2.55%
After-tax accumulation for the bond outside the IRA after 25 years = $4,000 × 1.0255^25 =$7,507.05.

Investing in IRA:
Since the IRA contribution is nondeductible, Kate invests $4,000.
Before-tax annual rate of return = 3%
After-tax annual rate of return = (1 - 0.15) × 3% = 2.55%
After-tax accumulation for the bond inside the IRA after 25 years = $4,000 × 1.0255^25 =$7,507.05.

Therefore, both investment options provide the same after-tax accumulation. However, investing in an IRA has the additional benefit of tax-deferral on any future gains.

Kate Can Invest $4,000 of After-Tax Dollars (AT$)directly in a Taxable