Retirement and Similar Accounts

Credit Card Repayment and Grow Tax-Free Accounts

The calculator that follows looks at the post-tax value at withdrawal of one post-tax dollar invested by the various means available to the typical investor in the United States. The calculations are based on the marginal (the last) dollar invested and withdrawn. The value at withdrawal of many of the investments depends on the current tax rates and the anticipated tax rate at withdrawal.

The calculator at this page provides the federal marginal tax rates and short and long term investment tax rates. Please consult your state tax web pages for state short and long term tax rates.

The first calculator provides the post-tax value at withdrawal of each dollar invested in 401-K with and without matching, Roth and Education IRA’s (529 education savings), credit card repayment, Health Savings Accounts (HSA),  non-dividend paying stocks, collectibles, and bank savings accounts and CD’s.

Assumptions for 401-K, Roth, and Education IRAs calculations include the assumption that monies are taxed by your state in the same manner as the federal. For 401-K: deposits are tax-free and withdrawals are taxed at the withdrawal state and federal tax rates. For Roth and 529 plans assumptions are that post-tax dollars are invested and withdrawals are tax-free. HSA accounts deposits are pre-tax and withdrawals are tax-free. Non-dividend paying investments (Stocks or Zero-coupon bonds) are deposited post-tax and interest is taxed at lower long term rates when held for more than a year. Collectibles are similar accept for a larger flat 28% tax rate on the appreciation over the cost of the asset.

The value of Bank Savings (such as Bank CDs, money markets or saving’s accounts) at withdrawal are underestimated as they are calculated under the assumption that the withdrawal tax rates are in effect only in the last one year prior to withdrawal and that the current tax rate holds till that time. Credit cards are like Roth IRAs as the ‘income’ (reduction in balances) is tax-free while payments made are from post-tax dollars. For more on credit cards see the following page.

There are four default scenarios. You can alter the blue cells and enter your own scenario. When marginal rates at withdrawal (retirement) are lower than marginal tax rates when investing, the 401-K investment is better than the Roth option. Scenario 1 looks at such a case. The values of the investments are highest for 401-K investments. In this scenario, one dollar is worth $5.2, $3.4 and $2.85 for the matched 401-k, unmatched 401-k and the Roth respectively.

When marginal rates at withdrawal are higher than the marginal rates when investing, as in scenario two, Roth and 529 educational plans can be much better investments than an unmatched 401-K. You can have higher marginal rates at withdrawal, for instance, if you anticipate paying for a child’s education during your peak income-earning years. Similarly, contributions to Roth IRA’s are good investments in lower-income years in your career such as those early in one’s career. In scenario two, one dollar is worth $3.59, $2.39 and $2.85 for the matched 401-k, unmatched 401-k and the Roth/education IRA respectively.

Except when there is matching, HSA accounts outperform both the ROTH and the 401-k accounts. In all scenarios, non-dividend paying taxable investments do better, for the same return rate, than holding collectibles.

The third scenario looks at credit card debt. Your ‘return’ for repaying your credit card is your annual APR on the card. The credit card rates tend to be higher than returns you would get from most other investments. The default example has an interest rate of 12% which can be compared against the more typical rate of earnings on investments of about 6% in scenarios one and two. It is worthwhile to compare the credit repayment alternative to other investments. In many cases, except sometimes for the matched 401-K, credit repayment is likely to be the better option. Compared to the 6% return options in scenarios one and two the 12% APR for credit leads to one dollar returning $7.69 versus $5.2 and $2.85 for the matched 401-k (scenario one) and the Roth (scenario two) respectively.

The fourth option looks at various bank savings (or mortgage repayment or CDs – Note that with a mortgage interest deduction the effective interest rate is lower than your mortgage rate depending on your tax bracket). A more realistic 3% return is used in this scenario.  As bank deposits to the tune of $250,000 are federally insured, this option leads to stable secure returns. Similarly, credit card APR tend to stay the same or increase and repaying credit cards remains preferable even if one has a credit card with APR closer to about the 6% in scenario one and two.

Edit the blue cells in the spreadsheet and enter your data and the calculations will refresh.

I saved the calculations I did when I worked out the equations for this spreadsheet and reproduce them below. This page of this website is dedicated to the Indian mathematician Ramanujam who is said to have scribbled many of his profound insights on the back of an envelope.