GF550 Unit 4 Qualified Plan Comparison by Tax Rate Example

Five Places for the Same Take-Home Dollar: A Unit 4 Qualified Plan Comparison for a 44-Year-Old Professional

[Student Name]

Purdue University Global

GF550: Retirement Planning

Unit 4 Qualified Plan Comparison

[Instructor Name]

[Date]

The client and every figure are composite and illustrative; dollar limits and income ranges are those published for 2025, and the article and publications cited are real.

The Client

The client is single, 44, and earns $165,000 as an operations manager. Her employer's 401(k) allows both pre-tax and Roth deferrals and adds 50 cents for each dollar she defers, up to 6 percent of salary, which she already collects. She expects to retire at about 65, with retirement income likely taxed at 22 percent at the margin. Today, after the standard deduction, her taxable income of about $149,000 sits in the 24 percent bracket.

The Comparison Method

Each vehicle is compared at the same cost to her take-home pay. A $10,000 pre-tax deferral reduces take-home pay by $7,600, since it saves $2,400 of tax at 24 percent. So the comparison asks what $7,600 of take-home pay becomes after twenty years at a 6 percent return, after all taxes, in each vehicle.

The Five Vehicles

1. Pre-tax 401(k) deferral. Going in: $10,000 deducted from taxable pay. During growth: no tax. Coming out: taxed as ordinary income. After twenty years, $10,000 grows to about $32,071; after tax at 22 percent, about $25,016.

2. Roth 401(k) deferral. Going in: $7,600 from after-tax pay. During growth: no tax. Coming out: tax-free once she is 59 and a half and the account has existed for five years. Value after twenty years: about $24,374.

3. Traditional IRA. Because she is covered by a workplace plan and her income is well above the 2025 phase-out range for single filers, $79,000 to $89,000, her contribution would not be deductible (Internal Revenue Service, 2024b). The nondeductible amount becomes basis in the IRA, tracked on Form 8606, so only the earnings are taxed when withdrawn (Internal Revenue Service, 2024a). A nondeductible $7,600 grows tax-deferred to about $24,374, but the earnings, about $16,774, are taxed at 22 percent on withdrawal, leaving about $20,684.

4. Roth IRA. Eligibility depends on modified adjusted gross income, which phases out direct Roth IRA contributions for single filers between $150,000 and $165,000 in 2025 (Internal Revenue Service, 2024b). The annual IRA limit is $7,000, so the comparison here uses that amount where she qualifies. Growth and qualified withdrawals are tax-free, the same as the Roth 401(k).

5. Taxable brokerage account. $7,600 invested in a stock fund paying 2 percent dividends, taxed at 15 percent each year, with the rest of the return as unrealized growth. After twenty years the account is worth about $23,031, and selling it triggers 15 percent tax on the gain above a basis of about $12,202, leaving about $21,407.

The Ranking

For equal take-home cost after twenty years:

1. Pre-tax 401(k): about $25,016.

2. Roth 401(k) or Roth IRA: about $24,374.

3. Taxable account: about $21,407.

4. Nondeductible traditional IRA: about $20,684.

The pre-tax deferral wins because she saves tax at 24 percent today and expects to pay 22 percent later. The Roth options are close behind. The nondeductible IRA is the weakest, because it turns what would have been lightly taxed capital gains into ordinary income.

The most useful finding is not the ranking but an interaction: pre-tax 401(k) deferrals lower her modified adjusted gross income, so deferring the full $23,500 pre-tax brings her to about $141,500 and makes her eligible for a full $7,000 Roth IRA, which Roth 401(k) deferrals would not.

Why the Interaction Matters

If she made all her 401(k) deferrals as Roth contributions, her modified adjusted gross income would remain about $165,000, the top of the phase-out range, and she could not contribute to a Roth IRA directly. By deferring the full $23,500 pre-tax, she both captures the 24 percent deduction and opens the Roth IRA. The result is a mix of pre-tax and tax-free savings, which protects her if tax rates in retirement turn out higher than she expects.

Tax Diversification

Research on where to hold assets when both taxable and tax-deferred accounts are available finds that the choice of account can matter as much as the choice of investment, and that holding some savings in each type gives flexibility in retirement (Dammon et al., 2004). A retiree with both pre-tax and Roth balances can draw from pre-tax accounts up to the top of a low bracket and from Roth accounts above it, managing taxable income year by year.

Sensitivity to the Retirement Tax Rate

If her retirement rate turned out to be 24 percent, the same as today, pre-tax and Roth would produce identical results, about $24,374 each. If it were 32 percent, the Roth would win by a wide margin. Because no one knows future tax law, splitting contributions guards against being entirely wrong.

Two Practical Cautions

First, the Roth IRA eligibility depends on her income staying within range after deferrals; a large bonus could push modified adjusted gross income above $150,000 and reduce the allowed contribution, so she should check before contributing late in the year. Second, the employer match is always made with pre-tax dollars under this plan, so even a fully Roth deferral strategy would leave her with some pre-tax balance.

Recommendation

1. Defer the full $23,500 to the 401(k) on a pre-tax basis.

2. Contribute $7,000 a year directly to a Roth IRA, which the pre-tax deferral makes possible.

3. Invest any further saving in a low-turnover taxable index fund rather than a nondeductible traditional IRA.

4. Revisit the split if her income rises above the Roth IRA range even after pre-tax deferrals.

References

Dammon, R. M., Spatt, C. S., & Zhang, H. H. (2004). Optimal asset location and allocation with taxable and tax-deferred investing. The Journal of Finance, 59(3), 999-1037. https://doi.org/10.1111/j.1540-6261.2004.00655.x

Internal Revenue Service. (2024a). Contributions to individual retirement arrangements (IRAs) (Publication 590-A). U.S. Department of the Treasury.

Internal Revenue Service. (2024b). 2025 amounts relating to retirement plans and IRAs, as adjusted for changes in cost-of-living (Notice 2024-80). U.S. Department of the Treasury.