11-01-2005, 11:13 AM #41 Thinks s/he gets paid by the post   Join Date: Oct 2005 Posts: 2,203 Re: As I learn more about investing, my 401k DOESNT look so great.... \$10k @ 4% x 30 yrs. = \$583,283 - 25% taxes = 437,462 \$7.5k @ 5.75% x 30yrs.= \$600,114 - 15%LT tax= 510,097 This i found on another site, but it relates. The first is a 401k with 2% expense ratio. The second is a taxable account with a .25% ratio. Both assume the same 6% overall eprformance. Even though the second is taxed 2x, it's more efficient by far. This is assuming at the beginning that the person is int he 25% bracket. Being in the 15% bracket puts the taxable, second option, way ahead of the game! I'll have to re-calculate assuming my specific scenario, 1.5% Expense ratio, and 15% tax bracket to see... EDIT: assuming the 401k earned 6%, had a 1.5% Expense ratio, and you contributed 10k pre-tax money yearly for 30 yrs, after a 25% tax in 30 yrs you'd be at 477k, 541k if taxed at 15% Assuming .3 ER on the taxable account leaves 572k, assumign a 15% capital gains tax ADVATNAGE: TAXABLE by either 95k, or 30k summary: 401k 10k/yr, for 30 yrs @ 4.5%=637k minus 25% tax=477k, 15% tax=541k Taxable 8500/yr, for 30 yrs @ 5.7%=673k minus 15% cap gains=572k , @ 5% cap gains=640k!! 25% bracket: 7500/yr @5.7%=594k minus 15% cap gains= 505k, 5% cap gains =564k. SO, if you are 15% now, taxable wins hands down If you are 25% now, and end up in 25% bracket, taxable wins by 28k If you are 25% now, and end up in 15% bracket, taxable wins by 13k Is my math flawed? __________________ __________________
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 11-01-2005, 11:52 AM #42 Moderator Emeritus   Join Date: Feb 2005 Location: San Diego Posts: 5,234 Re: As I learn more about investing, my 401k DOESNT look so great.... And then you have to think about whether you are a "pay the house off" or "enjoy the spread between mortgage and investments" type. With no house payment, you are withdrawing a much smaller amount per year to live, lowering your marginal tax bracket further, so regular IRA/401k looks even more attractive. I go back and forth on this one. DW and I put 28k (max) in 401k, but also put 8k in Roth IRA. I have a regular IRA with 3 previous years contributions in it, as well. I just figure I'll be all over the map, then when I do retire, I'll draw from the best buckets for my current situation. I'm thinking next year the Roth is a better choice for me, if DW stays home with the kid, our tax situation will be pretty nice. I certainly hope to be in a higher tax bracket when I retire, let's put it that way! :P __________________ __________________
 11-01-2005, 11:56 AM #43 Thinks s/he gets paid by the post   Join Date: Oct 2005 Posts: 2,203 Re: As I learn more about investing, my 401k DOESNT look so great.... But I think the overall gist of my last post is this: If you are in either the 25% or 15% bracket now, and end up in either the 15 or 25% bracket in the future....a taxable account will win hands down. (provided the returns are equal, and the 401k expense ratio is about 1% greater than that of the taxable account). PERIOD. This is very advantageous if you plan on withdrawing the money before age 60. You will pay penalties withdrawing from your IRA, ROTH, or 401k before 60. __________________
 11-01-2005, 12:12 PM #44 Thinks s/he gets paid by the post   Join Date: Jun 2005 Posts: 4,359 Re: As I learn more about investing, my 401k DOESNT look so great.... TheFed: Didn't I say that already ? Anyone that pays early-withdrawel penalties on qualified account withdrawels is mis-informed. There are ways to eliminate these taxes. __________________
 11-01-2005, 12:13 PM #45 Moderator Emeritus   Join Date: Feb 2005 Location: San Diego Posts: 5,234 Re: As I learn more about investing, my 401k DOESNT look so great.... 72t baby. __________________
 11-01-2005, 12:17 PM #46 Thinks s/he gets paid by the post   Join Date: Jun 2005 Posts: 4,005 Re: As I learn more about investing, my 401k DOESNT look so great.... Principal contributions to Roths are also withdrawable (is that a word??) at any time. The principal contribution is what you put in each year (the up to \$4000 amount). The earnings on contributions are subject to penalties and taxes if withdrawn early (unless SEPP under 72t). __________________
 11-01-2005, 12:27 PM #47 Thinks s/he gets paid by the post   Join Date: Jun 2005 Posts: 4,359 Re: As I learn more about investing, my 401k DOESNT look so great.... For the elimination of the early-withdrawal penalty, Here's a link that discusses the SEPP under 72t http://www.retireearlyhomepage.com/wdraw59.html __________________
 11-01-2005, 12:43 PM #48 Thinks s/he gets paid by the post   Join Date: Oct 2005 Posts: 2,203 Re: As I learn more about investing, my 401k DOESNT look so great.... Right. I forgot about that...lol. I learn so much that some stuff gets pushed to the back. SO,I could take equal payments for 5 yrs miniumum and avoid the 10% penalty. But do they tax you? __________________
11-01-2005, 12:46 PM   #49
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Quote:
 Originally Posted by thefed Right. I forgot about that...lol. I learn so much that some stuff gets pushed to the back. SO,I could take equal payments for 5 yrs miniumum and avoid the 10% penalty. But do they tax you?
Yes, and there are lots of rules that you have to obey, but its not tat burdensome.
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 11-01-2005, 12:49 PM #50 Thinks s/he gets paid by the post   Join Date: Oct 2005 Posts: 2,203 Re: As I learn more about investing, my 401k DOESNT look so great.... Ok. Do they tax you as regular income, or capital gains? Cap gains would be more beneficial obviously. Also, it appears al though there's a "Cap" on how much could be withdrwan using this SEPP method. If I needed it to last me 15 years only, that wouldnt work well. I wouldnt be able to draw it down fast enough....right? __________________
 11-01-2005, 01:21 PM #51 Thinks s/he gets paid by the post   Join Date: Jun 2005 Posts: 4,359 Re: As I learn more about investing, my 401k DOESNT look so great.... Any qualified plans are taxed at ordinary income tax rates, not capital gains (nice try though ) You are limited as to how much you can withdraw undet 72t. However if you can't live on the 72t withdrawels then just maybe you should still be working. To see how much you can withdraw, work through the calculator provided in the link from my last post. If you are 45 years old then you can withdraw around ~\$5800/year for every \$100 grand you have in an IRA (using present interest rates). __________________
 11-01-2005, 01:24 PM #52 Thinks s/he gets paid by the post   Join Date: Oct 2005 Posts: 2,203 Re: As I learn more about investing, my 401k DOESNT look so great.... LAST question: If my money's in a VANGUARD fund, taxable, and I earn, say, 10% that year. Do I pay that tax THEN, or when the funds are sold. Does the capital gains apply to funds as well as stocks? MASTERBLASTER: The 72t withdrawels would only be from the IRA. I plan on having a 401k I want to begin tapping at 60, possible SS at 65 or 70, a taxable acct to tap whenever etc. Thus, I'd only need to draw that account down for 15 years, then tap the others. __________________
 11-01-2005, 01:27 PM #53 Thinks s/he gets paid by the post   Join Date: Jun 2005 Posts: 4,359 Re: As I learn more about investing, my 401k DOESNT look so great.... Capital gains are due when the fund is sold. You need to learn about fund turnover rates and how that may effect you. In order to tap a 401K you'd need to roll it over into a (rollover) IRA. Then you could do the 72t distribution on the rollover IRA. There would be no early withdrawel penalty then. __________________
11-01-2005, 01:28 PM   #54
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Quote:
 Originally Posted by thefed If my money's in a VANGUARD fund, taxable, and I earn, say, 10% that year. Do I pay that tax THEN, or when the funds are sold. Does the capital gains apply to funds as well as stocks?
If your 10% gains are capital gains and no dividends, you pay no tax until those gains are realized (usually be selling the fund). If you had a 2% divi, and 8% increase in CG's, you would pay tax this year on the 2% divi if applicable. The 8 % would be taxed later when you realize those gains (usually be selling the fund). Capital gains distributions complicate the matter further. They don't increase your return any, but you are taxed on them in the current year.
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11-01-2005, 01:33 PM   #55
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Quote:
 Originally Posted by justin If your 10% gains are capital gains and no dividends, you pay no tax until those gains are realized (usually be selling the fund). If you had a 2% divi, and 8% increase in CG's, you would pay tax this year on the 2% divi if applicable. The 8 % would be taxed later when you realize those gains (usually be selling the fund). Capital gains distributions complicate the matter further. They don't increase your return any, but you are taxed on them in the current year.
Perfect. That makes a lot of sense. SO to minimize taxes TODAY, I'd like to find a fund with low divi's and a good yield. To minimize my tax when I "cash out", I'd look for one wiht higher divi's and the same return.

thanks guys. I know i have a lot of ?'s, but I hope theyre helping someone else too.
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11-01-2005, 01:53 PM   #56
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Quote:
 Originally Posted by justin The after tax money that you invest is going to be taxed twice - when you earn it and when you withdraw it far in the future.* The 401k money only gets taxed once - when you withdraw it.* Assuming your future rates will remain the same as the present, you're better off, tax wise, investing in a 401k.* Your future tax rates would have to increase in order for the taxable account to be a better option.* *
I'm a little late returning to this thread, but how do you figure that after-tax money is taxed twice? You pay the tax when you earn it, but when the remainder goes into the investment account it becomes part of the basis. That basis is no longer taxed, only the gains.

The 5% cell shows \$3525, which when I divide by .05 gives \$70,500. That's pretty close to \$80,501-\$10000, implying a \$10K basis. But wouldn't the actual basis be \$8000, and the 5% tax on the 30-taxable amount be .05x(\$80,501-8000)= \$3625? Admittedly that doesn't change the conclusion, but how do you validate the rest of your spreadsheet if an error like this sneaks in?
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 11-01-2005, 01:59 PM #57 Thinks s/he gets paid by the post   Join Date: Oct 2005 Posts: 2,203 Re: As I learn more about investing, my 401k DOESNT look so great.... nord: Your reply reminds me that I calculated wrong. I "paid" cap gains taxes on the ENTIRE amount, not just gains....duh. That would make the taxable accounts even more attractive in my situation. __________________
11-01-2005, 02:17 PM   #58
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Quote:
 Originally Posted by Nords I'm a little late returning to this thread, but how do you figure that after-tax money is taxed twice? You pay the tax when you earn it, but when the remainder goes into the investment account it becomes part of the basis. That basis is no longer taxed, only the gains. The 5% cell shows \$3525, which when I divide by .05 gives \$70,500. That's pretty close to \$80,501-\$10000, implying a \$10K basis. But wouldn't the actual basis be \$8000, and the 5% tax on the 30-taxable amount be .05x(\$80,501-8000)= \$3625? Admittedly that doesn't change the conclusion, but how do you validate the rest of your spreadsheet if an error like this sneaks in?
You caught a non-critical error in my calculations. However, it doesn't change the calculations that much. The basis of your investment sneaks off into irrelevancy as you go through decades of growth. When the growth over time is \$70,000 and the basis is \$8,000 instead of \$10,000, the error I introduced only throws off the amount of the capital gains by a few percent (close enough for back of the envelope calculations).

After tax money is taxed twice: as I stated above, basis sneaks off into irrelevancy over the passing of many decades. You have to pay tax on the after tax money once, so in effect it costs you, say, \$10k of pretax money to invest \$8k and pay \$2k of tax for the after tax investment option. Then, in thirty years, your basis is tiny relative to the expected gains. True, you don't pay tax on the basis (\$8k), but you are paying capital gains taxes on the increase in value (which will be many times larger than your basis). That is the second time you pay taxes. So maybe you are paying taxes ~1.8 times.

Prior to running these calculations, I thought there was some merit in investing in an after tax account and paying taxes at lower capital gains rates in the future.

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11-01-2005, 02:22 PM   #59
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Quote:
 Originally Posted by justin After tax money is taxed twice: as I stated above, basis sneaks off into irrelevancy over the passing of many decades.* You have to pay tax on the after tax money once, so in effect it costs you, say, \$10k of pretax money to invest \$8k and pay \$2k of tax for the after tax investment option.* Then, in thirty years, your basis is tiny relative to the expected gains.* True, you don't pay tax on the basis (\$8k), but you are paying capital gains taxes on the increase in value (which will be many times larger than your basis).* That is the second time you pay taxes.* So maybe you are paying taxes ~1.8 times.*
Nah, I don't see it that way. You earn money and pay taxes on it once. Then you invest it. The investments earn more money, which when withdrawn is taxed once. Total taxation of all the money-- once.

Quote:
 Originally Posted by justin Prior to running these calculations, I thought there was some merit in investing in an after tax account and paying taxes at lower capital gains rates in the future.
The logic works great as long as the calculations are correct!
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11-01-2005, 02:34 PM   #60
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 Originally Posted by Nords ...Admittedly that doesn't change the conclusion...
Nords, you already conceded that the small error I made did not change the outcome of the analysis I presented.

It may be semantics as to whether one is taxed once or twice in an after tax account, but the end result is you'll pay more tax and have less money if you invest in an after tax account instead of a tax deferred account. That is, assuming:

- same tax rate on earned income today and in the future.
-non-zero tax rate on capital gains
-identical investment options in tax deferred and after tax account

I may be a dunce for making a mistake in my earlier calculations, but If I'm missing something that changes the conclusion, please post it. Post a copy of your excel analysis if you want. I'm curious to see where you're coming from.
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