Optimal contribution strategy as a function of the optimal withdrawal decision making

Case of deductible IRA versus Roth IRA

Abstract

The issue of the attractiveness of the deductible IRA versus Roth IRA is revisited by combining the contribution phase with the withdrawal phase in the analysis. Previous related studies ignore the important implication that the optimal withdrawal sequence first takes funds held in the taxable account followed by the withdrawals from the designated retirement account such as an IRA that will ultimately affect the decision about the optimal contribution strategy. The optimal contribution strategy is not affected by the expected length of the retirement horizon in the flat tax rate environ­ment. In the presence of progressive taxes, the investor should contribute more to the Roth IRA if the retirement period is shorter and if he is more optimistic about the return his investments will produce. Required minimum distributions levied on the deductible IRA but not the Roth IRA do not materially affect the optimal contribution strategy. The decision to convert the funds at the existing deductible IRA to Roth IRA and the decision to start making contributions to a newly available Roth IRA do not necessarily point in the same direction: under some circumstances one should not convert yet make a contribution to the Roth account.