Roth IRA Conversion Calculator - Net Present Value Analysis Explained

 

The most frequently asked question about the DTS Roth IRA Vs. Regular IRA Analyzer (Roth IRA Analyzer) is "Is the
Opportunity Cost Of Money used to pay the rollover tax accounted for somewhere?"

YES!  One of the definitions for Opportunity Cost Of Money is Cost Of Capital or Discount Rate.  One of the program's
inputs is After Tax Cost Of Capital.  By entering what your client would earn, adjusted for the tax rate, with the funds
that were used to pay the rollover tax as the After Tax Cost Of Capital you account for the Opportunity Cost Of Money.

The program's Summary Report has columns for a cash analysis and a net present value analysis.  The cash analysis is easy
to understand and interesting, but is meaningless since it is arrived at by adding cashflows for different years.
Adding $100 from 2010 to $200 from 2011 makes no more sense than adding 100 apples to 200 oranges.  The net present
value analysis adjusts each year's cashflow by a discount factor arrived at using the After Tax Cost Of Capital.  It
is the net present value that should be used to determine whether a Roth IRA is better than a Regular IRA.

Now that you are convinced that you should pay attention to the net present value analysis, your next question will be
"What After Tax Cost Of Capital should I use?" 
Lets go back to the Opportunity Cost Of Money.  If your client needs to liquidate assets to pay the tax on the Roth
IRA rollover, what opportunities are being lost?  Would your client invested those funds in a money market fund earning
5% pre tax?  If so, the After Tax Cost Of Capital should be 5%, less the tax on 5%.  If your client has a booming
business with a 20% rate of return, the After Tax Cost Of Capital should be 20%, less the tax on 20%.


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