An Evaluation of T. Rowe Price's IRA Analyzer

by Dr. Gobind Daryanani
© 1998, Gobind Daryanani

The following copyrighted article is available exclusively on the Roth IRA Web Site:

The T. Rowe Price IRA Analyzer is currently the most widely advertised software program for assessing both Roth IRA Contributions and Roth Conversion (also referred to as Rollover). The Roth IRA Conversion allows clients to move their pre-existing Traditional IRA funds to a Roth IRA account. The client may convert their entire Traditional IRA account, with no maximum, to the Roth IRA account provided their joint Adjusted Gross Income (AGI) is under $100,000. The reader is referred to other articles on this website for the specific rules associated with the Roth Conversion. The purpose of this article is to evaluate the model used in the T. Rowe Price IRA Analyzer. The author has simulated this model on the computer and has compared the results with other programs available in the marketplace.

Table 1 lists the inputs required by the model for a sample case study. The results for this case are shown in Table 2. In this example, the client Mary has $600,000 in her Traditional IRA account. Mary wishes to compare two scenarios: A) she converts all of the Traditional IRA money to the Roth IRA in 1998, against B) she leaves her money in the Traditional IRA account. Mary is assumed to have sufficient assets outside the Traditional IRA account to pay for the additional taxes that will be needed for the conversion. To provide a fair comparison with the Roth Conversion case, it is assumed that in the No Conversion case she still has these Tax Savings assets which will grow at the specified 10% growth rate.

The additional tax required for the Roth Conversion is 40% of $600,000 (= $240,000). This tax is spread over four years from 1998 to 2001.

Mary can specify an Accumulation Period and a Withdrawal Period. In the Accumulation period (ages 61 to 80 in the example) it is assumed that she will only draw mandatory withdrawal funds from her Traditional IRA account. This mandatory withdrawal is the minimum withdrawal that she must withdraw, after age 70, per the IRS rules. She has selected the Joint Term Certain algorithm for these withdrawals. (The other alternate the T. Rowe Price program permits is the Joint Recalculation method). Even though the years from age 70 to 80 (in this example) are within the Accumulation period she is required to take these minimum withdrawals. The T. Rowe Price model assumes that she will use all of these mandatory withdrawals for expenses and that none of the funds go back into an asset growth fund. Referring to Table 2 these withdrawals are in cells F12 through F24. Any amount withdrawn from the Traditional IRA is taxed at the 40% tax rate she specified for the Accumulation period. This is the effective flat tax rate including both Federal and State taxes, assuming that State taxes have been used as a deduction in the Federal Tax calculation. The T. Rowe Price program provides an overlay help window with current Federal and State tax rates. Note that there are no mandated withdrawals needed from the Roth IRA account or from the Tax Savings accounts during the Accumulation period.

Next let us move on to the Withdrawal period, ages 81 to 95 in this example. The T. Rowe Price model assumes that all funds in all accounts (Roth Conversion, Traditional IRA and the Tax Savings accounts) will be totally used up by the end of the Withdrawal period. Thus all account balances at the end of the withdrawal period will be exactly $0. The amount of withdrawal is generally the same every year (just like an annuity that pays a fixed amount of dollars per year). It is further assumed that she uses up all of the money withdrawn in any year i.e. none of it is available for reinvestment. The T. Rowe Price model calculates this fixed annual amount after taking into consideration the taxes (if any) that need to be paid. In all cases the remaining balances in the accounts will grow at the specified growth rate of 10% per year.

As you may have noticed there is one scenario where the amount withdrawn from the Traditional account may depart from the fixed annual amount (see cells F32 to F37), and may deplete the account before the end of the accumulation period (see F38 and F39). This happens if the calculations show that the minimum required withdrawal per the IRS rules is more than the computed flat withdrawal. In that case the actual amount withdrawn will be the larger of the two numbers. These minimum withdrawals from the Traditional IRA can, and in this example do, reduce that account to $0 before the end of the specified Withdrawal period. In the Roth IRA case and the Tax Savings cases the withdrawn amount is always a fixed number right up to the end of the withdrawal period.

The comparison of the Roth Conversion and No Conversion is based on the total amounts that are withdrawn from the respective accounts. In Mary's case the Roth Conversion provides $3,302,359 more than the Non-Conversion case. This is an 84% advantage for the Roth Conversion case.

Even though the advantage to Mary is indeed very significant Mary will most likely want to consider other what-if scenarios before committing to give Uncle Sam $240,000 in taxes.

The following are some other factors to consider, which the T. Rowe Price model does not take into account:

Inflation: The T. Rowe Price model does not account for inflation. If one does assume an inflation rate of 3.5%, the Roth Conversion advantage drops to 67%. (The author has expanded the T Rowe Price model to show this). The difference in today's dollars (NPV) is $ 1,123,617 in favor of the Roth Conversion. Intuitively, one would expect this gap to close since the Traditional IRA withdrawals are drawn earlier in time and therefore have a higher NPV.

Beneficiaries: One of the main advantages of the Roth Conversion is that one can postpone withdrawals until after the life span of the client and that the term of the withdrawal can be stretched out considerably by, for instance, using the child or grandchild as the beneficiary. This tactic will greatly increase the relative advantage of the Roth Conversion. The T. Rowe Price model is conservative in that it requires the same withdrawal period for both the Traditional and the Roth IRA accounts.

Reinvestments: Another scenario Mary may want to consider is the effect on the results if she does not spend all of the withdrawals, but reinvests part or all of it in growth assets.

Tax rates will have a very significant impact on the results. It is not an easy matter to select one tax rate for the Accumulation period and one for the Withdrawal period. The tax rates may very well fluctuate considerably within these periods. Other questions: What if the IRS goes to a flat tax? What if the tax rate tables do not keep up with inflation? These should be analyzed either by using an expert professional or a suite of software programs. After all it is a very big move -- $240,000 to the IRS!!

Withdrawal Scenarios: What if Mary wishes to wait till 1999 for the Roth Conversion, or make installment payments to the Roth IRA over a number of years? This may reduce her tax rate. The answer to these issues would be outside the scope of the T. Rowe Price program.

While the T. Rowe Price Analysis is a great start towards the Roth Conversion process, clients would be well advised to take the next step of professional consultations or software modelling before taking the big plunge. This is particularly true if the amount being converted is considered substantial.