Roth vs. Deductible: New Contributions
How does a Roth IRA compare with a deductible IRA on new contributions?
Here are two case studies.
[Note: the contribution limit is now higher than $2000, but the principle illustrated here is the same.]
Case I
Here is a case where the Roth IRA offers no real advantage over a traditional deductible IRA.
Assume that you are already investing $1000 a year toward your retirement and can't afford to put away any more.
We'll assume a tax rate of 31%.

Deductible IRA 
Roth IRA 
IRA Contribution 
$1000 
$690 
Deduction 
 $310 
$0 
Total Actual Payment 
$690 
$690 
Note that you have less to contribute to the Roth IRA, because we're assuming you can't afford to commit more toward retirement than you currently are.
Now assume 20 years pass, and you're retired.
Assume that your account grew at 10% annually.
Consider the future value of this single contribution.

Value of Contribution 
$6,727 
$4,642 
Tax on Withdrawal 
 $2,085 
$0 
Money Left to Live On 
$4,642 
$4,642 
So the Roth IRA doesn't do a thing for you in this case.
You shouldn't expect the Roth IRA to help you if you're putting away less toward your retirement than the current $2,000 contribution limit lets you.
Case II
Here is what's probably a more typical case.
This time assume that you are investing $5000 a year toward retirement: $2000 in an IRA and the rest in a regular, nonsheltered account.
We'll still assume a tax rate of 31%.

Deductible IRA 
Roth IRA 
IRA Contribution 
$2,000 
$2,000 
NonSheltered Account Contribution 
$3,000 
$2,380 
Deduction 
 $620 
$0 
Total Actual Payment 
$4,380 
$4,380 
Once again assume 20 years pass, you're retired, and your account grew at 10% annually.
Consider the future value of this one year's contribution.

Value of Contributions 


IRA 
$13,455 
$13,455 
NonSheltered Account 
$11,394 
$9,039 
Tax on Withdrawal 
 $4,171 
$0 
Money Left to Live On 
$20,678 
$22,494 
Now Roth pays off. Why?
Essentially because it lets you shelter a greater percentage of your annual investment: $2000 posttax dollars instead of $2000 pretax dollars.
One thing to notice is that we assumed the nonsheltered account is taxed annually, which is about as bad as it gets.
But it turns out that no matter how taxefficient that account is, the deductible IRA can only approach, but never surpass the Roth IRA.
(This is actually a fun thing to prove to yourself  use the
popup calculator
to find the future values of $3000 and $2380, and take the difference.)
Conclusion
The Roth IRA does offer an advantage over a deductible IRA, if the total amount of your contributions (both to the IRA and to a nonsheltered account) is greater than the IRA contribution limit allows.
If you aren't maximizing your IRA contributions, then the Roth IRA will give you no advantage over a traditional deductible IRA.
