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Author: AcmeFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35392  
Subject: Re: And more of the same bad advice Date: 7/16/2002 8:32 AM
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It's the argument that you pay more taxes with a 401K than with the same low turnover stock investment (e.g., an index fund) in a taxable account that I find totally misleading—it's theoretically true, just not a good investment plan in the real world.

While it is theoretically true is many circumstances, it is hardly universally true. When I look at my "expected" situation, I find that the 401k is clearly better even assuming a higher tax bracket in retirement than I currently pay...unless I am doing something wrong anyway. Here is my set of assumptions (simplified somewhat for this forum):

Taxable 401k
Return 8% 8% (same investments in both places)
Fed Tax Rate 27% 36% (assume tax rate will increase at retirement)
State Tax Rate 6% 6% (already in GA's top bracket)
Cap Gains Rate 18% ---
Time 30 yrs 30 yrs (I am 30, so lots of time)

Starting $ $ 670 $1,000 (gotta pay those taxes if you don't put the money in the 401k)
Pre-tax End $6,742 $10,062
Post-tax End $5,649 $5,836

Thsi set of assumptions clearly favors the 401k...and this is ignoring the fact that there will be some taxes every year on the $670 placed in the taxable account due to dividends and other mutual fund distributions...even the best index funds have some of these.

So...the 401k ends up superior by about $200 even though the tax rate is higher in retirement than it is presently. And that ignores taxes on distributions and the flexibility of moving between investments to rebalance the portfolio once every year or so. And it ignores the 4% match my company gives me on the 401k. The down side of the 401k, on the other hand, is that you must begin mandatory distributions from the 401k at 70.5.

I max out both my 401k and my Roth IRA, so it is not a choice between those two...it is just a choice between 401k and taxable investments. And unless I am missing something, I think the 401k is clearly the better option for me at this time (the crossover from taxable being better to the 401k being better occurs at about an 18-year time horizon, but since I am only 30 I have much longer than that).

Is there anything I am missing here?

ACME
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