Mark is considering investing in either a tax-exempt municipal bond that yields 7% or a nondeductible IRA that contains investments that yield 10% before taxes. (Mark is ineligible to contribute to a Roth IRA.) Mark’s current tax rate is 35%, and he plans to make a single investment now with a 15-year investment horizon.
a. Using after-tax accumulations and annualized ATRORs, show that the nondeductible IRA outperforms the municipal bonds assuming Mark’s tax rate remains at 35%. Assume no additional penalty upon withdrawal from the IRA.
b. How high would Mark’s tax rate have to rise in Year n to make the municipal bond more attractive than the nondeductible IRA? Assume the 7% and 10% BTRORs remain constant over time.