ExpertMedium1 markMultiple Choice
CPA · Question 11 · Area I: Individual Compliance and Planning
A taxpayer, age 45, is in the 37% marginal tax bracket and expects to be in the 22% bracket in retirement. They have $23,000 to contribute to a retirement plan in Year 1. They can choose a Traditional 401(k) or a Roth 401(k). The contribution limit is $23,000 (stated). Assuming equal investment growth, which option yields the higher after-tax wealth at retirement?
A taxpayer, age 45, is in the 37% marginal tax bracket and expects to be in the 22% bracket in retirement. They have $23,000 to contribute to a retirement plan in Year 1. They can choose a Traditional 401(k) or a Roth 401(k). The contribution limit is $23,000 (stated). Assuming equal investment growth, which option yields the higher after-tax wealth at retirement?
Answer options:
A.
Traditional 401(k)
B.
Roth 401(k)
C.
Both produce the same result.
D.
Cannot be determined without the investment rate of return.
How to approach this question
Compare Current Tax Savings vs. Future Tax Cost. If Current Rate > Future Rate -> Traditional (take deduction now). If Current Rate < Future Rate -> Roth (pay tax now).
Full Answer
A.Traditional 401(k)✓ Correct
Traditional 401(k)
The decision rests on tax rate arbitrage. Traditional 401(k) contributions are deductible at the current high rate (37%) and taxed later at the lower rate (22%). Roth contributions are taxed now at 37% to avoid 22% tax later. Since Current Rate > Future Rate, the Traditional 401(k) is mathematically superior.
Common mistakes
Assuming Roth is always better because it's 'tax-free', ignoring the upfront cost.
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