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Hello Tax Stategies people,

I have recently started a new job complete with a new retirement investing option that I wanted to bounce off people to see if I'm thinking about it correctly. Beyond a mandatory retirement plan, I have the option to create two other accounts: a 403(b) and a 457(b) (no employer match for these). Both of these appear to function like a traditional IRA. I have enough squirreled away elsewhere that I won't have to depend on this new money, and I have a >20 year horizon 'til I will have to withdraw it. If I create these accounts, I'll likely invest the money in whatever low cost index fund is available (looks like Fidelity Spartan).

So my biggest tax question is, assuming I hold it over a year, am I converting what would be LTCG in a taxable account into regular income from the IRA? If so, does it make sense for me to fund these at all if I plan to invest in an index fund? My pros and cons:

Pro funding the IRA-type accounts:
Defer paying taxes on earnings for 20+ years

Less flexibility in choice of investments
Unable to access the money for 20+ years (should not be a big issue)
Converting LTCG to regular income may actually increase the tax due (?)
Index fund has lesser benefit from being in a tax-advantaged account

There may be changes in the LTCG tax rate
There may be changes in the way 403b/457b 's work

I don't really feel driven to put much in fixed income investments at present, but I could do that within this kind of tax-deferred framework, and then it would seem the benefits of deferring the taxes would be more dramatic. At any rate, I'd appreciate any comments on my situation.


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There are other "pro"s. The contributions to these accounts will not be taxed currently. So you will have more money working for you currently. There will also be a small tax drag on the non-tax deferred account, even if invested in index funds.

On the other hand, capital gains tax rates as well as regular tax rates are at lower levels than they have been in the past. There is no way to predict with certainty what will happen in the future.

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One other thing to think about is your tax rates now vs. your tax rates in the future.

Yes, long-term capital gain rates today are lower than ordinary income rates today. But you really need to consider two components to this.

First, for the amounts contributed to the plans, the proper comparison is ordinary income rates today (the amounts contributed to the 403b and/or 457 plans are not taxed right now) compared to the ordinary income rates when you eventually withdraw the money.

Next, you compare the tax rates on the income generated by the money between now and when it's retirement time (which will be a mix of ordinary and capital gain rates, depending on how the money is invested) to ordinary rates in retirement.

Basically, there is the potential for some arbitrage in tax rates from your current rate to your retirement rate. Unfortunately, that calls for a really good crystal ball to determine the future tax rates. Or, more realistically, you project the future rates based on current tax laws and the known changes, including inflation indexing.

--Peter <== thinking the crystal ball may be the easier approach
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