Message Font: Serif | Sans-Serif
 
UnThreaded | Threaded | Whole Thread (15) | Ignore Thread Prev Thread | Next Thread
Author: zenbro Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 25265  
Subject: tax deferred money in 401k Date: 2/7/2006 2:41 PM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 1
Does anyone else wonder if it is wise to tax defer money from your
paycheck, during a time of low tax levels, into a 401k plan ??
With the unresolved issues of social security, medicaid, and the
national debt, it seems highly likely that the tax rate will have
to get raised in the future. So are we deferring the chance to
pay a low rate now, for a higher rate in the future ?
Print the post Back To Top
Author: SirYoda Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20073 of 25265
Subject: Re: tax deferred money in 401k Date: 2/7/2006 2:45 PM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
With the unresolved issues of social security, medicaid, and the
national debt, it seems highly likely that the tax rate will have
to get raised in the future. So are we deferring the chance to
pay a low rate now, for a higher rate in the future ?


===================================================

Sounds like Suze Orman. See this recent thread here on this very Board:

http://boards.fool.com/Message.asp?mid=23653308&sort=whole


Print the post Back To Top
Author: jbking Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20074 of 25265
Subject: Re: tax deferred money in 401k Date: 2/7/2006 2:51 PM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 2
Greetings,

Does anyone else wonder if it is wise to tax defer money from your paycheck, during a time of low tax levels, into a 401k plan ??

Well, if you are in the 0% bracket or something similar then I could see a sense of wondering but if your bracket is something like say 25% or more then it may be more worthwhile to defer the taxes.

Secondly, does this factor in matching, instituational forms of funds, e.g. compare VITPX to VTSMX to see a bit of a difference in expenses here, and other things or is this assuming just the tax part of the picture?

With the unresolved issues of social security, medicaid, and the national debt, it seems highly likely that the tax rate will have to get raised in the future.

While I would agree with that one level, what you mean be future has to be resolved: Is that future in 4 years, 10 years, 20 years, 40 years, or just somewhere in the future that may or may not be during my lifetime?

Additionally, while taxes have to go up which I'd agree on that point, if this isn't an income tax increase then it may not play a role here. Suppose that the US implements a national sales tax so that the income tax rates remain pretty much the same or go away and that sales tax replaces income taxes?

So are we deferring the chance to pay a low rate now, for a higher rate in the future ?

You can guess yes or no but you can't prove either answer, IMO.

Regards,
JB

Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Print the post Back To Top
Author: ziggy29 Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20075 of 25265
Subject: Re: tax deferred money in 401k Date: 2/7/2006 6:09 PM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
Personally if I were in a low marginal federal tax bracket (10% or 15%), I'd much prefer a Roth IRA to a 401K, and after that I'd hedge my bets between a taxable account and a 401K plan.

I would hedge because we don't know what the tax structure will be decades from now. Will it be a higher tax bracket than now? Will long-term capital gains and dividends still be taxed at less than marginal rates? Will the income tax be supplanted by -- or accompanied by -- a new national sales tax as ballooning unfunded liabilities come due?

I'd hate to bet heavily on one scenario and be wrong; hence, I would hedge my bets.

#29

Print the post Back To Top
Author: bmillz Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20083 of 25265
Subject: Re: tax deferred money in 401k Date: 2/8/2006 1:34 AM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
One additional feature of a tax advantaged account is that you don't have to worry about the tax implications of distributions. Especially in the case of mutual funds, this can save you a lot of hassle. You don't have to worry about capital gains from the sale of individual stocks in the mutual fund or dividends. It all just gets roled into the account and taxed at the end (or not taxed at all in the case of a Roth). This can be especially nice if your mutual fund sells a bunch of stock in a down market. In that case, through a traditional account you could be faced with a high tax liability at the same time as a low share price.

Print the post Back To Top
Author: zenbro Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20089 of 25265
Subject: Re: tax deferred money in 401k Date: 2/8/2006 10:20 AM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
Thanks for the replies. You all raised some good points, and I appreciate the input.

Print the post Back To Top
Author: Hawkwin Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20090 of 25265
Subject: Re: tax deferred money in 401k Date: 2/8/2006 10:24 AM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
Triple compounding is something that has to be considered regardless of your tax bracket -- assuming you pay any taxes.

If you pay 10%, for every $100, you would pay $10 in taxes. That $10 could sit in a tax deferred account for some 40 years earning you interest instead of that $10 being paid to the government. Sure, you may (and I am beginning to think likely) pay a higher tax at the time of retirement but even if you are now paying 15% in taxes on that $100, that $10 you saved likely would have grown to about $300 assuming just an 8% return. Roth IRA benefits withstanding.

Print the post Back To Top
Author: Rhodnius Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20094 of 25265
Subject: Re: tax deferred money in 401k Date: 2/8/2006 3:16 PM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 4
When you defer taxation with a 401k, there also exists an effect dubbed "bracket shifting". This effect can result in you paying less taxes overall even if you're in the same marginal tax bracket in retirement.

Suppose you make $60000 in 2005 as a single filer and put nothing in the 401k. You're in the 25% marginal bracket and your tax liability is $11665, calculated as $4090 + 25% of the amount over $29700. (see here for the bracket schedule: http://www.fairmark.com/begin/bracket.htm )

Now, suppose you make the same $60000, but deposit $30000 in a tax-deferred 401k amount, then you withdraw that amount in the year 2030 when you're retired. You're still in the 25% marginal bracket in both years. But your tax liability this year is only $4165, and your tax liability in the future year is also only the same $4165, for a total of $8330. That's almost $3000 less!

Why did this happen? Because you got to take advantage of the low-end brackets (10% and 15%) in two separate years rather than in just one year. If you took the upper half of your income in 2005, all of it would be taxed at 25%. But you can instead shift that income into the low-end brackets in 2030 so that only some of it is subject to the 25% marginal rate.

Hope that helps,
- Erik



Print the post Back To Top
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: 20101 of 25265
Subject: Re: tax deferred money in 401k Date: 2/10/2006 1:29 PM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
Suppose you make $60000 in 2005 as a single filer and put nothing in the 401k. You're in the 25% marginal bracket and your tax liability is $11665, calculated as $4090 + 25% of the amount over $29700. (see here for the bracket schedule: http://www.fairmark.com/begin/bracket.htm )

The general idea of what you are saying is correct, but you have incorrectly interpreted the information you reference.

If you make $60K in 2005, you will pay much less than $11,665 in Federal taxes. You have ignored the standard (or itemized) and personal deductions that decrease your taxable income. Also, $30K earned will result in less than $4165 in Federal taxes.

Correcting your numbers...assuming standard deduction ($5000) and personal deduction ($3200):

$60K income --> $9615
$30K income --> $2905

Paying the $2905 twice rather than $9615 once results in a difference of $3805. BUT...this is still overly simplified since we are ignoring any other sources of income (Soc. Sec., etc.) that push your bracket up somewhat during retirement. All the same, you can easily end up paying less in taxes this way even if your marginal bracket goes up during retirement.

Acme

Print the post Back To Top
Author: TMFJester Big red star, 1000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20102 of 25265
Subject: Re: tax deferred money in 401k Date: 2/10/2006 1:55 PM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
Paying the $2905 twice rather than $9615 once results in a difference of $3805. BUT...this is still overly simplified since we are ignoring any other sources of income (Soc. Sec., etc.) that push your bracket up somewhat during retirement. All the same, you can easily end up paying less in taxes this way even if your marginal bracket goes up during retirement.

Man. There you go confusing the issue with facts, again!

Print the post Back To Top
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: 20103 of 25265
Subject: Re: tax deferred money in 401k Date: 2/10/2006 2:04 PM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
Man. There you go confusing the issue with facts, again!

Heh...someday I'll stop being such an engineer... :^)

Acme

Print the post Back To Top
Author: PayingFool Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20104 of 25265
Subject: Re: tax deferred money in 401k Date: 2/10/2006 2:13 PM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
Now, suppose you make the same $60000, but deposit $30000 in a tax-deferred 401k amount, then you withdraw that amount in the year 2030 when you're retired.


Ummm, how would you manage that? The maximum for pre-tax 401(k) contributions in 2006 is only $15000.

Print the post Back To Top
Author: TMFJester Big red star, 1000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20105 of 25265
Subject: Re: tax deferred money in 401k Date: 2/10/2006 2:27 PM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
Ummm, how would you manage that? The maximum for pre-tax 401(k) contributions in 2006 is only $15000.

Jeez. More facts again.

Actually, if you're self-employed you can contribute to a SEP. But, with the facts above, it still wouldn't be possible because you're limited to the lesser of 25% of your income or $42K I believe. Since we're focusing on the facts today, I Just wanted to throw in my little fact. :-)

Print the post Back To Top
Author: Rhodnius Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20106 of 25265
Subject: Re: tax deferred money in 401k Date: 2/10/2006 3:49 PM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
You're both right. In the interest of simplicity, I ignored deductions and the limit on 401k contributions. The point isn't the precise final tax liability number, it's the fact that the number is lower despite being in the same marginal bracket, which is still true.

Adding in Social Security or other retirement income (from a hobby or part-time work or real estate or something) does indeed change the situation, since those will "fill up" the lower brackets in future years and push the 401k withdrawals out. In other words, the relative advantage of the bracket-shifting effect is higher if the 401k is expected to be your only source of money in retirement, or lower if you expect to have other income.

Print the post Back To Top
Author: shortUSD Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20180 of 25265
Subject: Re: tax deferred money in 401k Date: 2/25/2006 11:59 AM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
You don't have to worry about capital gains from the sale of individual stocks in the mutual fund or dividends. It all just gets roled into the account and taxed at the end (or not taxed at all in the case of a Roth).

but those long term cap gains will be taxed at a MUCH higher rate when you take the money out. you better get a LOT of compounding in the meantime to overcome that disadvantage.

-USD
... all bonds in my retirement accounts, stocks in taxable accounts

Print the post Back To Top
UnThreaded | Threaded | Whole Thread (15) | Ignore Thread Prev Thread | Next Thread
Advertisement