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One thing is, if I invested that amount of money outside the 401(k), e.g., in VFINX, I'd only have to pay capital gains tax, which would be lower.

You would pay income tax on the principal before you get it, then pay capital gain taxes on the gain.

Pretend for an instant that $1 invested in the S&P500 today will grow to $10 by your retirement. You choose to invest 401k or open a taxable account at Vanguard, and we'll assume the index account throws off no taxable dividends or capital gain payments (which it probably will do each year...). I'll assume your tax rate is 27%.

401K: $1000 invested today grows to $10,000 at retirement. You pay $2700 in taxes and walk off with $7300.

Taxable: $1000 pretax is $730 after-tax. $730 invested today grows to $7300 at retirement. You pay $1314 in capital gain taxes and walk off with $5986.

If you expect your tax rate to be very high at retirement compared to your tax rate now (a "problem" I'd like to have ;), then a 401(k) might not be the best deal. But, if you expect your tax rate at retirement to be anywhere near your current tax rate, a tax-deferred 401(k) is a good deal.

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