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Old 07-11-2017, 07:57 AM
 
272 posts, read 166,505 times
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I am trying to get at the meat of the financial advantage. I fully understand that the money grows tax free and that I may be in a lower tax bracket in retirement (but without a guarantee that the tax percent will be lower). However, those are not what I am concerned with in this post. What I want to look at is purely the end financial difference and why one is more advantageous than the other.


To start with a simple comparison using 25% as the tax amount for the deposit and withdrawal. Say Person A makes a one time tax-deferred contribution of $5000 of income to a retirement fund the day before they retire and it miraculously earns 7% interest in that one day. For the sake of this conversation it is the only contribution they ever make and they withdraw the full amount the next day. Person B does the same exact thing except they use after tax income ($3,750) to make the one and only contribution.


If when they deposit and withdraw the money they are in the 25% tax bracket would it work out as follows or am I missing something?


Person A would have turned $5,000 into $5,350 with the 7% gain. They pay 25% in taxes on the withdrawal of $5,350 leaving $4012.50.


Person B would have turned $5,000 of income into a $3,750 deposit after they immediately pay the 25% tax. After earning 7% their total would be the same $4,012.50. However, they now owe taxes on the gains of $262.50 which would mean they still owe $65.63 bringing their total after all taxes to $3,946.87.
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Old 07-11-2017, 08:40 AM
 
20,930 posts, read 15,210,628 times
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The math is correct however it's an over simplified example. You have three possible buckets, taxable accounts, tax deferred and tax free growth. Using a combination of the three spreads risk around and can provide flexibility. Draw from the tax deferred up to a certain income amount either tax free or very low tax, supplement with the taxable account and last take from the Roth if needed
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Old 07-11-2017, 10:06 AM
 
272 posts, read 166,505 times
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Sure it's an oversimplified example but gets to the point quicker/better (IMO) than any financial person (Accountant, Broker, internet article or Financial advisor) has ever done when trying to explain it to me. They always seem to concentrate on the Tax-deferred growth and possible lower tax bracket when retiring. The much bigger advantage may be having the earnings only taxed once rather than repeatedly taxed. They always seem to concentrate on the total amount the tax-deferred account will have when what I am really interested in is my after tax amount. How does option A compare to B in after tax dollars.


To give a slightly less simplified example but still simplified...


If Person A makes the $5000 one-time only contribution at the beginning of their career and never makes another contribution they would have $74,872.29 before tax at the end of 40 years. Which after tax of 25% would be $56,154.22.


Person B making their one-time $3,750 contribution would have the same $56,154.22 but would have had to pay an extra $65.63 in the first year all the way up to $918.41 in year 40 for the tax due on those earnings every year. That adds up to a large number.


If that is correct then I may have to start contributing more than the company match to my retirement account.
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Old 07-11-2017, 10:40 AM
 
Location: Florida
4,969 posts, read 4,362,199 times
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yes confusing.
The taxes on the growth of the 3,750 maybe at 15% depending on your income. Dividends and interest would be taxed at your 25% rate each year.
You should also do your analysis using a ROTH. You will pay no taxes on the 3,750 growth and related income.
If your 401k has a ROTH option consider that.
Another problem is that your RMD at age 70 1/2 may force you into a higher tax bracket and higher medicare insurance premiums.
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Old 07-11-2017, 02:07 PM
 
Location: OH>IL>CO>CT
5,847 posts, read 9,391,942 times
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Quote:
Originally Posted by rjm1cc View Post
yes confusing.
The taxes on the growth of the 3,750 maybe at 15% depending on your income. Dividends and interest would be taxed at your 25% rate each year.
You should also do your analysis using a ROTH. You will pay no taxes on the 3,750 growth and related income.
If your 401k has a ROTH option consider that.
Another problem is that your RMD at age 70 1/2 may force you into a higher tax bracket and higher medicare insurance premiums.
And possibly a higher rate of means testing taxability of any Social Security benefits.

See https://www.ssa.gov/planners/taxes.html
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Old 07-11-2017, 02:43 PM
 
Location: The Triad (NC)
30,231 posts, read 66,756,813 times
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Quote:
Originally Posted by Grumpty View Post
I am trying to get at the meat of the financial advantage.
I fully understand that the money grows tax free
and that I may be in a lower tax bracket in retirement
(but without a guarantee that the tax percent will be lower).

However, those are not what I am concerned with in this post
.
Perhaps not... but those are "the meat" of the topic.

Quote:
What I want to look at is purely the end financial difference
and why one is more advantageous than the other.
The rest will always be too personal, specific and conditional
to offer up more than other broad statements.

You clearly have a good grasp of YOUR personal and specific conditions.
Sharpen your pencil and run a few scenarios.
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Old 07-11-2017, 11:48 PM
 
7,756 posts, read 8,164,893 times
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The Roth IRA does not have an RMD -- does the Roth 401K have the RMD at 70 and 1/2 (like other 401ks?)
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Old 07-12-2017, 05:00 PM
 
902 posts, read 443,955 times
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Yes.
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Old 07-12-2017, 09:07 PM
 
3,531 posts, read 2,055,847 times
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Why doesn't the fact that the government is basically funding 25% of the non deferred contribution seem to be a much discussed benefit? You're essentially getting an immediate 33% roi. That seems like a big pro to me.
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Old 07-12-2017, 09:23 PM
 
20,930 posts, read 15,210,628 times
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Quote:
Originally Posted by hellob View Post
Why doesn't the fact that the government is basically funding 25% of the non deferred contribution seem to be a much discussed benefit? You're essentially getting an immediate 33% roi. That seems like a big pro to me.

What are you talking about?
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