Qualified Plan Return Potential

Increasing the withdrawal tax bracket will decrease the internal rate of return and decreasing the withdrawal tax bracket will increase the return.

Let us use rate of return first.

Let us assume a $5,000 annual contribution with a match of $2,500 and an investment return of 5%. If we look at three working periods of your life (in this case each period is for ten years) and keep the tax bracket at 30% for all three periods as well as at the time of withdrawal we will see that the investment's overall internal rate of return is 7.18%. If we change the withdrawal rate up we will notice that our rate of return will go down.  If we change the withdrawal rate down we will notice that our rate of return will go up.  The tax rate at the time of withdrawal has a dramatic impact on what happens to the money from a qualified plan.

The math for this proof is solved with four worksheets: First, Second, Third and All Periods.

Each worksheet calculates the growth and cash flow for each year.  The cash flow for years of growth is the contribution made less any tax deferral.  The tax deferral is the amount of taxes deferred by making the contribution.  It is an apparent tax savings, whether it is a true tax savings or not depends on the tax bracket at the time of withdrawal compared to the current tax bracket.  

The cash flows are presented in the last column.  They are negative during the years of investment.  The negative means a cash outlay or investment.  A positive cash flow is shown in the last column of the last row.  This cash flow assumes the investment has been ended and the taxes due at withdrawal have been paid.  It is under the last row with a year number because it occurs at the end of the last year, compared to all the other cash flows occurring at the beginning of the year.

The internal rate of return function is used to calculate the rate of return.  You can verify the rate of return by entering the cash flows into a calculator or spreadsheet with the internal rate of return function.