The Financial Feasibility of Tax-Sheltered Individual Retirement Plans: Comment

Abstract

Gahin [2] offers an analysis of tax-sheltered individual retirement plans (section 403(b), IRAs, Keoghs, etc.) which focuses on the net cash flow (i.e., net present value, discounting for mortality and investment earnings). He concludes tax sheltered annuities (TSAs) are not an attractive savings mechanism for a younger individual whose tax rate will be higher following retirement. These results conflict with those of Adelman and Dorfman [1], who also examined tax-deferred annuities where the tax rate during the withdrawal years exceeded the tax rate during contribution years. Although Adelman and Dorfman ignored mortality, they concluded on the basis of internal rate of return measurements that even in the worse case the TDA performs well in time, and the unfavorable results only occur if one were to jump from a relatively low to a relatively high tax bracket in a short period of time just before withdrawing a TDA.(p. 89) The purpose of this note is to refine the work of Gahin to incorporate the deferral of taxes on investment earnings in tax-sheltered retirement plans, an advantage not recognized in the model. The results reaffirm the conclusions presented by Adelman and Dorfman.