After-Tax Returns to Different Types of Accounts

Let’s assume five different types of accounts are available:

1. A taxable account where the funds are withdrawn to spend during life
2. A taxable account where the funds are left for heirs
3. A deductible IRA (or 401(k), 403(b), etc. the math is the same)
4. A Roth (or again a Roth 401(k), 403(b), etc. the math is again the same)
5. A non-deductible IRA

Let’s further assume:

1. The tax treatment of a Roth remains the same (i.e. tax fee growth).
2. Investments held until death continue to receive a step up in basis as they do currently.
3. The investment throws off no dividends or interest and there is no portfolio turnover during the holding period.
4. There are no RMDs (Required Minimum Distributions) on any accounts.

Interesting and notable (and counter-intuitive to most folks) findings:

• The rate of return is actually completely irrelevant to which investment is superior, but it will increase the magnitude of the differences between the different types.
• If the ordinary income tax rate remains the same – regardless of the level – it is a three way tie between the deductible IRA, the Roth, and the taxable account held until death.
• If the ordinary income tax rate increases, it is a two way tie between the Roth and the taxable account held until death.
• If ordinary income tax rates decrease, the deductible IRA wins.
• The non-deductible IRA never wins under any circumstance (with my assumptions, but with dividends, interest, and turnover it can beat a taxable account).
• The taxable account never wins, but if capital gains rates are low enough, it can beat the deductible IRA in the case where ordinary income rates increase significantly (for example, if capital gains rates are 20% and ordinary rates are currently 25%, but go to 37.5% it will be a tie.  If they increase to above 37.5%, the taxable account would win).  But note that the Roth would have beat both by a wide margin.