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Author: duggg Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121333  
Subject: Re: Cap gains or income? Date: 5/17/2001 1:12 PM
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mschorer writes,

I was trying to figure out whether it made much difference to take retirement withdrawals from income-earning investments or from cashing in cap gains type investments, given that one can structure either way.

Keep in mind that even though long term capital gains rates are significantly lower than ordinary income tax rates, retirement vehicles such as IRAs and 401(k)s may still give you more money in your pocket in the long run, because the investment grows tax-deferred.

To illustrate, suppose you contribute $5000 of your gross income to your employer's 401(k) plan. At a rate of 8%, it grows to $34,242 in 25 years. You then retire and withdraw it over several years, paying 15% ordinary income tax of $5136, leaving you with $29,106.

However, the same $5000 of gross income will give you only $4250 in net income, if you're in the 15% tax bracket, since you pay the taxes up front. That $4250 grows to the same $29,106 at the same 8% over the same 25 years.

But, you still have the 10% capital gains tax of $2486 to pay on the difference between $4250 and $29,106, leaving you with only $26,620.

Although you pay more in total taxes by investing in a 401(k), you still end up with more money in your pocket, in most cases.

The advantage disappears only if you're above the 29% ordinary income tax bracket during retirement---a pretty rare situation.
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