I created a spreadsheet to look at the issue of "fairness" between income taxes and capital gains taxes. To do this, I compared what present value in an IRA would be required to match a sample take home pay stream, and what taxable account present value would be required to also match the take home pay stream. The IRA is equity based, but is taxed as income and avoids SS and Medicare taxes. The taxable account is equity based and is taxed as capital gains..
Assumptions:
The IRA starts with a present value that is all pre-tax and magically appears.
The starting tax basis in the taxable account is $0. This seemed fair since non of the IRA starting balance was taxed. Like a really good stock option grant.
I used the 2012 federal tax table, with brackets adjusted for inflation after the first year.
I used fixed 3% yearly inflation, inflation+2% salary increases, inflation+6% equity growth, 7.65% SS+Medicare taxes when calculating take home pay, 15% capital gains rate, a $60k starting salary, and a 35 year career. The initial take home pay was $47,280.
The results:
The IRA requires an initial balance of $1,078,462.
This was enough to make yearly withdrawals (start of year), pay the income tax, and net the target take home pay for 35 years. The IRA balance after 35 years is $0.
The taxable account requires an initial balance of $1,086,383.
This was enough to make yearly withdrawals (start of year), pay the capital gains tax, and net the target take home pay for 35 years. The taxable account balance after 35 years is $0.
(A Roth account requires $923,425)
Actually pretty close, I think.
The breakeven point (equal IRA and taxable account starting values) in this case is about 14.38% capital gains tax. Can't get much closer to even than that.
The comparative result did not change much with different investment gain assumptions. Probably because they are both equity based.
Here's the results for different starting salaries:
$20k IRA: $361,940
$20k Taxable: $377,972
$30k IRA: $542,911
$30k Taxable: $558,942
$40k IRA: $723,574
$40k Taxable: $739,605
$50k IRA: $901,877
$50k Taxable: $916,120
$60k IRA: $1,078,462
$60k Taxable: $1,086,383
$70k IRA: $1,253,044
$70k Taxable: $1,249,242
$80k IRA: $1,428,502
$80k Taxable: $1,406,750
$100k IRA: $1,783,840
$100k Taxable: $1,719,358
As expected, capital gains taxes look better than income taxes as you average income tax rate rises.
Assumptions:
The IRA starts with a present value that is all pre-tax and magically appears.
The starting tax basis in the taxable account is $0. This seemed fair since non of the IRA starting balance was taxed. Like a really good stock option grant.
I used the 2012 federal tax table, with brackets adjusted for inflation after the first year.
I used fixed 3% yearly inflation, inflation+2% salary increases, inflation+6% equity growth, 7.65% SS+Medicare taxes when calculating take home pay, 15% capital gains rate, a $60k starting salary, and a 35 year career. The initial take home pay was $47,280.
The results:
The IRA requires an initial balance of $1,078,462.
This was enough to make yearly withdrawals (start of year), pay the income tax, and net the target take home pay for 35 years. The IRA balance after 35 years is $0.
The taxable account requires an initial balance of $1,086,383.
This was enough to make yearly withdrawals (start of year), pay the capital gains tax, and net the target take home pay for 35 years. The taxable account balance after 35 years is $0.
(A Roth account requires $923,425)
Actually pretty close, I think.
The breakeven point (equal IRA and taxable account starting values) in this case is about 14.38% capital gains tax. Can't get much closer to even than that.
The comparative result did not change much with different investment gain assumptions. Probably because they are both equity based.
Here's the results for different starting salaries:
$20k IRA: $361,940
$20k Taxable: $377,972
$30k IRA: $542,911
$30k Taxable: $558,942
$40k IRA: $723,574
$40k Taxable: $739,605
$50k IRA: $901,877
$50k Taxable: $916,120
$60k IRA: $1,078,462
$60k Taxable: $1,086,383
$70k IRA: $1,253,044
$70k Taxable: $1,249,242
$80k IRA: $1,428,502
$80k Taxable: $1,406,750
$100k IRA: $1,783,840
$100k Taxable: $1,719,358
As expected, capital gains taxes look better than income taxes as you average income tax rate rises.