You received a surprise $1,000 bonus and rather than spending it, you decided to allocate the amount toward your retirement savings. In particular, you are opening a tax-deferred account and you need to decide between a traditional IRA and a Roth IRA. You are currently in the 35% income tax bracket. Moreover, you are planning to withdraw the money from your tax-deferred account in 10 years, at which point you expect to be in the 24% tax bracket.

Based on your answer to the previous question, are you better off (in expected value terms) investing your $1,000 in a regular IRA or a Roth IRA when the expected return is 10 percent per year?

If the expected return of your mutual fund is 10.3 percent (which happens to be the average return for the S&P500) rather than 7.1 percent, would your answer be different? Explain. Discuss, in particular, how expected returns and the expected tax bracket determine which type of account you should open.