Case Studies: A Lifetime of Maxing Out an IRA

Start NowStart Now · Part 7. A free series on building your own tax-free pension, one move at a time. New here? Start from the beginning →Thanks for reading Start Now! Subscribe for free to receive new posts and support my work.Greg M. Ostroff, CFARunning the Numbers · Chapter ThreeCase Studies: A Lifetime of Maxing Out an IRAThis section brings it all together, following real people through the plan, dollar by dollar. If you love numbers, dig in. If you don’t, relax: there aren’t many, and each one is here to bring a real person’s story to life.Case Study · Maya, 30At 30, she’s a physical therapist at a small private clinic, no big employer, and no retirement plan waiting for her. A few years in, she’s cleared her training debt, and after watching older colleagues retire on far less than they’d hoped, she decides she won’t be one of them. So she opens a Roth IRA, contributes the maximum every year until she retires at 70, and then leaves the balance invested, drawing a sustainable income from it rather than cashing out.Let’s track three identical-contribution strategies side by side: a Roth IRA, a Traditional IRA, and an ordinary Taxable account, and ask two questions for each age from 70 onward: what is the after-tax lump sum worth, and what annual income would a 4% withdrawal provide? (Age 30 is used as the base because many people begin disciplined saving after a few years of working; Chapter 4 shows what changes if you start earlier or later.)Assumptions* Contributions: Maya puts in the 2026 IRA maximum of $7,500 a year, rising to $8,600 at 50 with the catch-up.5 The first run holds that amount flat; the second grows it 2.5% a year.* Investment return: Every conclusion is built on the 8% floor, the worst 30-year stretch on record (Section 1.4). The tables also show the 10% long-run average, and Section 3.2 shows the full range.* Taxes: Withdrawals from the Traditional IRA are taxed at 24%, and gains in the Taxable account at 15%.6* Comparability: Every figure is after tax, meaning spendable dollars. The Roth needs no adjustment because it is already tax-free.* Inflation: Some tables also state values in today’s dollars, so a future balance can be read in purchasing power you recognize today.7* The age rows: Contributions run through age 69 and stop at 70. The rows for 75 and 80 show that same balance left to compound untouched. A Roth has no required minimum distributions, so leaving it alone is a real choice, and the tax-smart order is to draw down taxable and traditional accounts first and the Roth last. Those rows show what the money does if left alone, not a rule that anyone must wait.* Total contributed over the 40 years (ages 30–69): $322,000. Every dollar beyond that comes from compound earnings, not from saving.3.1The base case: the 8% floor, with the 10% average alongsideStart at the floor. Eight percent is the worst 30-year return on record, and it is the growth rate this book assumes. At an 8% growth rate, a maxed-out Roth reaches $2,152,723 by age 70. That generates about $86,000 a year at a 4% withdrawal rate during retirement. At the 10% long-run average, the same plan reaches $3,720,692. The tables below show both, side by side, across all three account types. Each figure appears twice: in nominal dollars, the balance you would actually see on the statement that year, and in today’s dollars, what that balance would buy at today’s prices. The second number is always smaller, because decades of inflation erode what a dollar buys.The four tables that follow all use the 10% long-run average, not the 8% floor.The floor is what the plan is built to survive; the average is what the plan has more often actually delivered, and it is the fairer basis for comparing the three account types against each other. The 8% floor results appear in Section 3.2, and the two sit side by side in Deep Dive B.Table set one · What the balance is worth at 70 and beyondThe after-tax lump-sum value at age 70 and beyond, assuming the 10% average return, for all three accounts:After-tax lump-sum value, in nominal dollars. Start age 30, flat contributions, the 10% average return. (Selected ages shown.)The same table, in today’s dollars (2% inflation), so the figures can be read in purchasing power you recognize:After-tax lump-sum value in today’s purchasing power. Start age 30, flat contributions, the 10% average return, 2% inflation.Table set two · What it pays out each yearAnd the annual income a 4% withdrawal would generate, depending on the age at which withdrawals begin:First-year income from a 4% withdrawal, after tax, in nominal dollars. Start age 30, flat contributions, the 10% average return.The same income, in today’s dollars (2% inflation):First-year 4% withdrawal income in today’s purchasing power. Start age 30, flat contributions, the 10% average return, 2% inflation.The lump-sum figures assume the balance is left untouched to keep compounding, while the 4% income figures show what you could instead draw in the first year if you began withdrawing at that age. You do one or the other, not both, because the two are the same pile of money: every dollar you withdraw stops compounding, so a balance you are drawing income from cannot also be the balance that grew untouched to the figure in the first table.For simplicity all three accounts are modeled as left untouched after 70. In practice a Traditional IRA faces required minimum distributions beginning at 73, which would draw it down somewhat; a Roth has no such requirement, so its untouched-compounding figures are exact.Reading the tables. At age 70, assuming the 10% average return, the Roth holds $3,720,692 of tax-free wealth, the highest of the three. The Taxable account comes next at $3,185,373. And, perhaps surprisingly, the Traditional IRA trails at $2,827,725. Section 3.3 explains why. The Roth’s lead is structural and percentage-based, so it widens in dollars every year: by age 80 its edge over the taxable account alone is about $1,534,127.NoteYield on Cost, the number that should matterMost savers fixate on the size of the nest egg. The number that actually matters is the cash flow it can sustainably throw off, measured against what you paid to get it.Take the 10% average case from the tables above. Over her career, Maya contributed $322,000. Her first year of retirement income, drawing 4%, is $148,828. In one year she takes out nearly half of everything she ever put in, about 46 cents for every dollar contributed. Then she does it again the next year, and the year after that.Investors call this yield on cost. Both percentages describe the same $148,828 of income, and each one is a yield: think of it as the interest rate the money is paying her. Measured against her balance of $3,720,692, that income is a 4% yield. That is the number everyone quotes, and it is the rate she is drawing from the account. Measured against the $322,000 she actually contributed, the very same income is a 46% yield. That is the number almost nobody looks at, and it is the one that shows what her contributions did: every year, they hand her back 46 cents for each dollar she ever put in. Because it is a Roth, that 46% is entirely tax-free, and it rises every year with inflation; wait until 80 to begin drawing and the yield on cost approaches 120%. No bond, dividend stock, or annuity bought at today’s prices can be made to do this. It can only be grown into, by starting early and refusing to sell.These are nominal figures: about 46% on the 10% average case, and about 27% even at the 8% floor. What they are worth after inflation, in today’s dollars, is shown by the today’s-dollars tables in Section 3.1 above.Even after inflation, the result is life-changing. The Roth’s age-70 balance of $3,720,692 is worth about $1,685,065 in today’s money. That throws off roughly $67,403 a year in today’s purchasing power at a 4% withdrawal. It is entirely tax-free, and it comes from a lifetime contribution of $322,000. That is the magic of compounding inside a tax-free wrapper.3.2What you can and can’t controlSection 3.1 built on the 8% floor and the 10% average. The best 30 years the market has delivered on record is 13.6 percent, the ceiling of what has actually happened. The full floor-to-ceiling tables, across ages 70 to 80, are laid out in Deep Dive A.NoteYou can’t control the return, only whether you keep showing upWhether the market hands you 8% or 13.6% has an enormous effect on the final number, far more than how much you contribute or which account you use. That return is not yours to choose. The forces that set market returns, the era you invest through, the economy, the wider world, are almost entirely outside your control. So the rate you ultimately earn is largely out of your hands.What is fully within your control is something else. Keep investing, regularly and automatically, for as long as you can. Maximize your time in the market. Do not stop, do not panic, and do not sell before you reach retirement and are ready to draw the money down. You cannot control the return, only whether you keep showing up. That, over a lifetime, is the whole game. And the range itself carries its own reassurance: even the pessimistic 8% case still produces a very comfortable retirement. You supply the discipline; the floor is already high.And if the contribution limit keeps rising? Everything above holds the limit flat at today’s $7,500, deliberately conservative, since the IRS does raise it over time. Let contributions grow 2.5% a year and total lifetime contributions climb from $322,000 to about $552,000, 71 percent more money, which lifts the age-70 result from $3.72 million to $4.82 million. That is about 30 percent more wealth. Helpful. Hardly transformative.Now set that against what the next chapter is about to show. Starting five years earlier, at 25 instead of 30, costs you only 12 percent more money, but it produces 61 percent more wealth.Put those two results side by side. They are this entire book, compressed. Contributing 71 percent more money, later in life, buys you only 30 percent more wealth, but contributing 12 percent more money, earlier in life, buys you 61 percent more wealth. The late route costs roughly six times as much extra money and delivers less than half the extra wealth. The dollars that build real wealth are not the biggest ones. They are the earliest ones, because they are the only dollars that get to compound for the entire run. Rising limits are a nice tailwind. Starting now is the engine. (The full tables, and why a smooth 2.5% slightly flatters the real stair-step path, are in Deep Dive B, “If Contribution Limits Keep Rising”)3.3A surprising result: when a Traditional IRA trails a taxable accountThe tables show the Roth comfortably ahead, but they also show something that surprises many people: the Traditional IRA finishing behind an ordinary Taxable account. This is not an error. It follows directly from two facts. First, this book assumes the realistic behavior that the Traditional IRA saver spends the annual tax deduction rather than investing it. Second, a Traditional IRA withdrawal is taxed on the full amount as ordinary income, here 24%, whereas a Taxable account is taxed only on its gains, at the lower long-term capital-gains rate of 15%. The Taxable account does pay a small tax on its dividends every year along the way. But that yearly drag is smaller than the hit the Traditional IRA takes at the end, when the entire balance is taxed at the higher ordinary rate. So the Traditional IRA finishes a step behind.It is important not to over-read this. The Traditional IRA is not a bad choice. Every year, its deduction puts real cash in the saver’s pocket, money that funds their lifestyle along the way. That benefit simply never appears on an end-of-life balance sheet, which is all these tables measure. A disciplined saver who had invested each year’s deduction in a side account would have finished nearly even with the Roth; most savers do not. The realistic takeaway: for the typical person who would spend a Traditional IRA’s tax break, the Roth is not merely better. It is dramatically better, because it forces every tax-advantaged dollar to keep working, tax-free, instead of leaking away as everyday spending.✦3.4What happens at 70Maya turns 70. Over forty years she has put in $322,000, $7,500 at a time, on a physical therapist’s salary at a clinic that never offered her a plan.At the long-run average she is sitting on $3,720,692. If her forty years instead turn out to be the worst forty the market has ever produced, she has $2,152,723. In today’s purchasing power those are roughly $1.69 million and $975,000. She never earned a fortune, never picked a stock, and never had to be right about anything. Even her bad case is the retirement her older colleagues never got.The day the job changesFor forty years Maya’s job was accumulation, and an all-stock portfolio was the right tool for it, because every decline along the way was a discount on her next purchase. At 70 that reverses. She is no longer a buyer but a seller, and a decline is no longer a discount; it is a forced sale at a bad price. So she does what a prudent retiree does and moves a share of the portfolio into bonds and cash, enough to fund several years of spending without touching stocks at all. That is also the balanced mix the withdrawal-rate research assumed in the first place. Accumulating and drawing down are simply not the same job.(Deep Dive F takes up what that shift involves, what it costs, and what can still go wrong.)Doing it inside a Roth is worth a great deal. Maya’s balance contains $3,398,692 of pure gain. In an ordinary taxable account, moving 40 percent of it into bonds and cash would trigger about $203,922 in federal capital gains tax, and $330,353 in California. That is charged purely for the privilege of rearranging her own assets, at the moment she most needs them intact. Inside the Roth she owes nothing. Every dollar stays in the account and keeps working.A Traditional IRA would not tax the trade either. But it carries a larger problem: every dollar that comes out is taxed as ordinary income. The same lifetime of contributions that leaves Maya $3,720,692 in a Roth is worth $2,827,725 in a Traditional. $892,967 of it was never hers. She was never as rich as the statement said, and the Roth statement is the only one that tells the truth.What the pension paysNow the account has to do its actual job. At the classic 4 percent, Maya’s first year is $148,828 on the average case and $86,109 at the floor. In today’s money that is about $67,000 and $39,000, and not one dollar of it is taxed, ever. The payment rises with inflation every year after that.It is worth understanding what that 4 percent is. It is not the typical outcome. It is the rate that survived the single worst retirement start in American history, someone who stopped working in the late 1960s just ahead of a decade of high inflation. Bengen’s revised never-failed figure is about 4.7 percent, which would pay her $174,873 in her first year. He puts the average across all other historical periods near 7 percent. This book plans on 4 percent anyway, on purpose, so that every surprise runs in her favor.Nor was the rule ever built to leave her at zero. The Trinity Study ran every thirty-year retirement from 1926 to 1995, and a balanced portfolio drawn at 4 percent, raised each year for inflation, lasted the full thirty years in 39 of the 41 periods. The authors’ own conclusion was that at 3 and 4 percent, retirees “who wish to bequeath large estates to their heirs will likely be successful.” She is not spending her wealth down. She is living on what it throws off. Deep Dive F takes up the two periods that failed, and the things a real retiree does that the simulation does not.None of this required her to be clever. She opened an account at 30, funded it every year, left it alone, and changed the mix once, at the end, when the job changed.✦Coming next: 4 · It Pays to Start EarlyA NOTE FROM THE AUTHORStart Now is free to read and free to share. A new part publishes free every Sunday. Subscribe to get each part in your inbox as it goes out.If you find that it helps you, the kindest thing you can do is subscribe and pass it to one person who needs it.If you’d like to give back, pay it forward: donate any amount to a cause you believe in. I don’t collect a penny of it; it goes straight to the charity you choose, not to me. If you’d like a suggestion, I support the Zach Moses Music, Love & Light Fund at the Sweet Relief Musicians Fund, which feeds musicians in need. sweetrelief.org/zachmoses →Questions, comments, or a story of your own? Leave one below, or just reply to this email; I read every one.Thanks for reading Start Now! Subscribe for free to receive new posts and support my work. 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