Naive 401k/403b question

[GeoffD]

Originally Posted by Lowexpectations

And if you pull it out at a 45% tax rate is it a benefit? It's simply tax deferral the possible benefit or negative outcome comes later

Unless you are massively high income in a state with a giant state income tax, nobody pays 45%. If you're that high income, it probably doesn't matter whether you have a 401(k) or not. You have hundreds of thousands in income from other sources.

[Lowexpectations]

Originally Posted by GeoffD

Unless you are massively high income in a state with a giant state income tax, nobody pays 45%. If you're that high income, it probably doesn't matter whether you have a 401(k) or not. You have hundreds of thousands in income from other sources.

I don't know what the tax rates are going to be in 30 years, do you?

[Energystream]

It allows you to re-balance your portfolio as often as you want. I would consider that a benefit.

[jw2]

Originally Posted by JO783

Thanks for the replies so far!

To be clear, I know what a Roth account is, it's not about definitions. I just specifically see people saying you should contribute to that preferentially over other options (say, maxing the 401k). Avoiding RMD makes sense, but I'm not certain that would be enough for me to miss out on the tax benefits of putting more into the 401k.

Both Traditional 401K and Roth 401ks do not have the gains taxed. This is the benefit! This is a lot more obvious on the Roth, in fact that is how it is described. But the net effect of Traditional IRAs/401ks are the same as Roth IRAs/401ks. This can be demonstrated with examples and can be easily explained.

To get the same amount into what you deposit into a Traditional IRA/Roth, you would take the after tax amount. As an example, if you are in the 25% bracket and you deposit $10,000 into a Traditional IRA, the equivalent Roth IRA deposit would be $7,500. That additional $2,500 (25% of the total) in the Traditional IRA grows at the same rate as the rest of the IRA. At the end of the term, you can take 25% off the top and you will end up with what the balance of the Roth IRA is.

Let’s say after 5 years, the account values doubled. The Roth is worth $15,000. No taxes due because of the nature of Roth accounts. The Traditional is worth $20,000. If we are still in a 25% tax bracket, there are $5,000 taxes due making the account worth $15,000. Same as the Roth.

What has happened is the "tax" portion (which in the Traditional was that first $2,500 and was deferred) has appreciated along with the rest of it. So in our example, is 25% of the balance through the life of the fund. (it isn't really a tax portion, only for the purpose of the discussion assuming that you would exit at the same 25% rate)

If the tax rate at the time of entry to the IRA/401k is the same as the tax rate at the time of exit from the IRA/401k, there is no difference between Roth and Traditional, at least as far as how much taxes are paid. So, the real differences are when you want to declare income and when you feel you will be in a lower tax bracket.