Year Start Rebalancers

[Gumby]

Can someone explain to me why $100K in tax deferred isn't worth as much as $100K in taxable. I don't quite understand the logic/reasoning behind that statement.

Thank you.

Because you have already paid the taxes on the money in your taxable accounts, but you have yet to pay the taxes on the amount in the tax deferred accounts.

 

[nico08]

Because you have already paid the taxes on the money in your taxable accounts, but you have yet to pay the taxes on the amount in the tax deferred accounts.

Ok, I understand that I will already have paid income tax on the taxable account, because the contribution came from post-tax income. But won't I still have to pay short or long term capital gains tax on that account too?

If I use the money from a tax deferred account, I will have to pay income tax and any applicable short or long term capital gains tax on that money?

I guess I get confused between income tax and capital gains tax on taxable and tax deferred accounts.

Thank you for your help.

 

[Gumby]

Ok, I understand that I will already have paid income tax on the taxable account, because the contribution came from post-tax income. But won't I still have to pay short or long term capital gains tax on that account too?

If I use the money from a tax deferred account, I will have to pay income tax and any applicable short or long term capital gains tax on that money?

I guess I get confused between income tax and capital gains tax on taxable and tax deferred accounts.

Thank you for your help.

Let's use some numbers for comparison. Assume you are in the 25% marginal tax bracket. Assume you are 60 years old:

Taxable account: You invest $100 in SPY, which rises 20% in a year and a day. When you sell, your gain is $20 and you pay 15% in long term capital gains. You will then have $117 ($100 plus $20 gain minus $3 tax) to spend.


Tax deferred account (e.g. 401k): You invest $100 in SPY, which rises 20% in a year and a day. When you sell and withdraw the money to spend, you will have to pay $25 in tax on the original amount. You will also have to pay $5 in tax on the $20 gain, because all gain in the 401k is treated as ordinary income. You will then have only $90 to spend ($100 plus $20 gain minus $25 tax on original amount minus $5 tax on gain).

QED -- $100 in a taxable account is worth more than $100 in a tax deferred account.