Taxable Accts vs Pre-Tax Accts...Balance?

[TomCat]

Good Morning...I am working on some yearend planning and am again facing a question.

Both wife and I are self-employed and have Individual 401(k) accounts. These accounts allow for some significant tax "deductible" contributions. What I do each year is use TurboTax to calculate a with and without tax bill (Fed and State) based upon different amounts of 401(k) contributions. I usually make contributions as long as the tax "savings" (deferral) is at least 30-35%...often a bit higher.

Background...at his stage (age 62) we have accumulated investment balance pretty close to allowing for projected retirement needs...it is however, about 70% in the "retirement" pre-tax accounts...ie; we will owe taxes as we withdraw.

While this has all happened "knowingly" ...I thought it mught be interesting to get some thoughts as to whether this continues to make sense?

Assuming our tax deferral is between 30-40% of 401(k) contributions...and assuming the contribution is essentially a transfer from a taxable investment account into the 401(k)...do you feel it is reasonable to continue to move investment dollars into pre-tax accounts...fully recognizing we will be taxed as we withdraw in the future. Probably will begin withdrawing say within 3-5 years? Don't worry about capital gains on the taxable assets for this question.

My general thought is that we are still better off continuing our practice of transfering funds as 401(k) contributions...knowing that it will all be taxable as we withdraw? Ya I also know we should pay the taxes from the annual earnings but it seems we spend much of our self-employment earnings and draw tax amounts from invested $$$s

Thanks for your thoughts...TomCat

 

[samclem]

I've been doing something similar to what you are doing--using my self-employed income as a means to move money from my "regular" (non-tax favored) savings into my solo 401K.

The main determinant as to whether this makes sense for you is the comparison between your present (marginal) tax rate and the (marginal) rate you expect to be paying in retirement. If you're paying tax at a higher rate now (I am) then it makes sense to contribute to your solo401K at least to the point where you decrease your taxable income to get into the bracket you'll be in after you retire.

Also, this year and next year we have low cap gains taxes, the rates are scheduled to go up in 2011. So, if you've got appreciated assets, this might be the time to sell them.

Don't forget that tax rates and bracket cutoffs are unlikely to stay static over the time of your retirement. I think its safe to assume rates will go up and the brackets cutoffs might creep down as we figure out that there just aren't enough "rich" folks t pay off the debts our government is building up.