Higher Taxes Loom for 401(k) Savers

[obgyn65]

Those of us with a large 401k plan may take a hit sooner rather than later... I will keep saving money in my 401k plan but would like to hear your views.

Higher Taxes Loom for 401(k) Savers - WSJ.com

 

[MasterBlaster]

This shouldn't be a big surprise to anyone.

Remember though that 401k taxes not paid when working/saving are at your marginal rate. The tax due when the money is withdrawn is at marginal rates above the SS tax formula and a pension (if you have one). The average rates above SS(taxable) and your pension just may be lower than your marginal rate when working even with higher future rates.

In other words barring issues with SS and pension and other income, the 401k when paid out, gets taxed at something kind of like an average tax rate. But when working you saved taxes at your marginal bracket. If the future average rate is less than your current marginal rate then you still come out ahead.

Everyone's situation in different though. Nonetheless, I suspect that we will all be paying more in taxes in the years ahead. That's the trend.

It gets kind of hard to optimize the nestegg when the rules are so uncertain.

 

[W2R]

I am enjoying living (partially) off withdrawals from the TSP (=401K).

I think most people are aware that 401K money isn't just magically tax free forever somehow. Right now, my taxes on this money are far lower than they were when I was working.

The author has a point that taxes may go up in a few years. This reinforces my conviction that it is important to diversify not only investments, but income streams. The more income streams coming at me from a variety of sources, the better. Sure, have a Roth as well as a 401K! No reason to have all one's eggs in one basket.

 

[Aiming_4_55]

It really depends on your personal situation. I see this for reason to retire early (before pension draw and/or SS) so one can withdraw or do a Roth conversion at the lowest tax rate per your desired tax bracket assuming it is lower than your working tax bracket.

Also, this would make one really think about an unpaid leave or sabbatical for a year or two, then using a roth conversion paying taxes at a lower tax rate for future use.

 

[samclem]

In other words barring issues with SS and pension and other income, the 401k when paid out, gets taxed at something kind of like an average tax rate.

Yes, but the 401K gets taxed at the income rate, whereas gains would have been taxed at the (lower--at least today) cap gains rate if the money hadn't been put into a 401k.

It gets kind of hard to optimize the nestegg when the rules are so uncertain.

+1. It's good to have a mix of buckets (pre-tax, Roth, 401K/TIRA) so we can continue to optimize as the rules change.

 

[steelyman]

It really depends on your personal situation. I see this for reason to retire early (before pension draw and/or SS) so one can withdraw or do a Roth conversion at the lowest tax rate per your desired tax bracket assuming it is lower than your working tax bracket.

Also, this would make one really think about an unpaid leave or sabbatical for a year or two, then using a roth conversion paying taxes at a lower tax rate for future use.

This makes sense to me and I hadn't thought of it this way before although I will personally not be able to take advantage of it. I'm sorry the notion of a Roth 401(k) or 403(b) was not made available earlier than it was, as I don't mind paying the tax today while taxes are still low than later on. The instant they made the Roth employer plan available to us, I switched from a traditional plan to a Roth. Hopefully, that'll give me a little leeway for tax diversification when it comes time to withdraw.

 

[MasterBlaster]

Yes, but the 401K gets taxed at the income rate, whereas gains would have been taxed at the (lower--at least today) cap gains rate if the money hadn't been put into a 401k.

You have made an assumption that cap gains will have favorable tax status going forward. It just may be that all of that reverts to marginal tax rates.

 

[walkinwood]

Everyone's situation in different though. Nonetheless, I suspect that we will all be paying more in taxes in the years ahead. That's the trend.

Where did you see that trend?

We just got a continuation of the bush cuts with some added sweeteners & even in this high tax state of NJ, I don't see any tax increases. We just got a 2% prop tax cap - with conditions, of course (it is, after all NJ), but the trend I'm seeing here is spending cuts, not tax increases.

I understand people 'expecting' higher taxes in the future.

 

[MasterBlaster]

WalkingWood:

What exactly is your point here ? We don't need to turn this into a political rant.

I suppose though that it could be done sans taxes with huge societal costs. Somethings gotta give though, With the Boomers medicare and SS and our ever increasing debt...

Increased taxes will inevitably be part of the mix. That's how many people see it.

 

[Hamlet]

I think most people are likely to pay a lower tax rate when they withdraw from their 401k than they do when they put it in, unless the tax structure is radically changed, or they have so much investing success that they end up with a much higher retirement income than their working income.

There isn't really any meat to this article.

 

[Independent]

I think the article in the OP is kind of conventional wisdom on this forum. Traditional IRAs and 401k's are better if you expect to pay taxes at a lower rate when you're withdrawing, Roths are better if you expect to be paying taxes at a higher rate.

The unknowns are the complexity of taxes in retirement (what about RMDs if you've deferred SS?), multiple bands (like MB says), and changes in tax laws.

 

[Andre1969]

Even though you might pay higher taxes when you withdraw your 401k money, is there at least some consolation that it's had the chance to grow and compound, possibly for decades, tax free?

I got hit pretty hard this year with capital gains taxes. Now true, capital gains are only at the 15% rate or whatever, whereas I'd be in the 25% bracket if that was taxed as income. But I think it still might be worth it to keep the money in a 401k and avoid that 15% rate every time you get a capital gain, even if you have to pay a higher tax rate on whatever you end up pulling out at retirement.

I guess if you're invested in funds and such that never rarely post a capital gain, it might not be a good argument.

 

[ziggy29]

I'm currently deferring taxes from the 25% bracket. I have to hope that my marginal rate is below 25% when I start withdrawing. As my current plan is to be as asset rich and income poor as possible for the purposes of taxation and entitlements, hopefully this would lead to a tax rate below 25% even in the future with what I expect will have to be higher rates overall. (Of course, the wild card would be a significant overhaul of the tax system, especially one that partially replaces an income tax with a consumption tax.)

Also, since I live in a state with no income tax, if we moved to a state with an income tax that would also be a net reduction in the value of the deferral.

 

[FinanceDude]

Old news..........

 

[MasterBlaster]

Even though you might pay higher taxes when you withdraw your 401k money, is there at least some consolation that it's had the chance to grow and compound, possibly for decades, tax free?

No with higher (marginal) brackets in retirement you would be better off in a ROTH type account. Better yet an after tax account that pays capital gains on profits when withdrawn would be the best way to go (under current law).

Tax Brackets and IRA choices

1) If your marginal tax bracket will be higher in retirement then a ROTH is the way to go.

2) If tax brackets are the same during the working years as when you take the money out...

then one dollar [earned, invested in a deferred tax plan, and then withdrawn in retirement and taxes then paid]

is exactly equal to :

the one dollar[ earned, paid taxes on when earned, invested in a ROTH plan and then withdrawn in retirement]

provided the term is the same and the investment rate gain is the same.

3) IF marginal tax rates go down in retirement then go with the deferred plan. If marginal tax rates go up in retirement then go with the ROTH.

Good luck with predicting your future tax rates and future tax policy some decades out ! If your income is at least what you make now then I would predict that your retirement income tax rates will be at least as high (or higher) than they are now. MY magic 8-ball says that for you perhaps the ROTH is the way to go.

 

[samclem]

No with higher (marginal) brackets in retirement you would be better off in a ROTH type account. Better yet an after tax account that pays capital gains on profits when withdrawn would be the best way to go (under current law).

You have made an assumption that cap gains will have favorable tax status going forward. It just may be that all of that reverts to marginal tax rates.

Like me, you were clear in stating the assumptions.