I understand that 401k contributions are treated as deferred income so they will be taxed at my (presumably lower) tax rate when I am retired and over the age cutoff. I also understand that this taxation applies to all of the investment returns that accrue on my 401k contributions between now and my retirement. But what happened to the capital gains (other investment) taxes that I would have to pay on investments that I made with my after-tax income? It seems that the 401k is a way to avoid paying capital gains taxes and other investment taxes, since all I do is pay the income tax. To illustrate what I am asking, assume that my current and retirement tax rates are both 10% so the deferred tax benefit is absent. Also assume that I have the same investment option inside and outside the 401k and it doubles my initial investment. I am comparing two scenarios for what I could do with $1000:1) Put it in the 401k. My $1000 grows to 2x$1000=$2000. Subtract 10% income tax on all of it. I end up with $1800. 2) Keep it outside of the 401k. My $1000 gets taxed and I have $900. My $900 grows to 2x$900=$1800, but now I have to pay 15% capital gains tax = 0.15*$900. I end up with less: $900+$900*(1-0.15)=$1665. It seems that the 401k investments are exempt from investment taxes. Is this actually correct or is there some catch in the withdrawal process? NOTE: I am assume a withdrawal after the age cutoff (59 1/2), so there are no penalties.
What you say is correct - you don't pay any tax while the money is in a 401k, only once you take it out and then at your income tax rate (unless it is a Roth 401k, in which case you already paid the tax at contribution time and won't pay tax at exercise).
pabloso,Sounds nice except the capital gains rate in the 10% marginal rate is 0%. So your $1,800 is equal in both.Plus, in the taxable account, you can use the money at any time without a 10% penalty for early use, like to retire early as I did.A taxable brokerage that allows you a full latitude of investments, where you buy securities and hold them long-term, not short-term in and out trading, can build more wealth than high fee, mediocre investments available in far too many 401ks. Your individual plan may or may not have great options to invest in.Everything coming out of traditional accounts, IRAs and 401k/403b/etc, is subject to income tax and the accounts are all subject to RMDs(Required Minimum Distributions(as is a Roth 401k)).One big benefit of tax-advantaged accounts is the regulations to keep the money in the account for retirement and not spend it early. Too many people spend money if they have two nickels to rub together. These accounts push them a little harder to save.Gene
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