Skull Pilot
Diamond Member
- Nov 17, 2007
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Huh? What are the drawbacks?
If I purchase $10,000 stocks, or any investment, and it triples in value, and I sell it, I have to pay $5,000 in taxes, eating up a good chunk of the increase.
If I put $10K in any investment through a 401K, and it triples in value, it grows in value tax free.... correct?
What is the drawback? Explain please. I don't understand.
A 401 k is not tax free it is tax deferred
Look at the way your 401 is taxed when you take the money out.
ALL of the contributions and ALL of the gains are taxed as regular income.
The government forces you to take required minimum withdrawals every year. If you do not take out the required amount you get heavy tax penalties.
Now compare that to a non qualified plan.
Your money is categorized as principle ( the after tax money used to purchase investments) and gains (the actual growth of your investments)
If you invested 100K and it grew to 1 million you would not be taxed on the 1ooK investment and the rest would be taxed at the lower capital gains rate of 15%
Now let's say you only need 40K to live on. In a non qualified investment you only have to take out what you need and can leave the rest in to continue to grow thereby making your nest egg last longer.
In a 401 or other qualified plan the government would force you to take the required withdrawal even if it was more than you needed to cover your expenses and all of that withdrawal is taxed at the higher regular income tax rate. So you pay more taxes than you have to and your nest egg will be depleted faster.
IMO those are significant drawbacks.
Roth 401K / IRA? My understanding is that there is no minimum distribution in Roths. Even so, the required distribution is fairly low, don't you think? From what I've read, the RMD on a $500K traditional 401K, is about $18K. At $18K a year, that would be 27 years, assuming that you picked such horrible funds, that there was zero increase for 27 years. Not to mention the RMD doesn't start until you hit 70, which means that, again assume zero increase for 27 years, means you'll run out at 97 years old?
A Roth is an after tax investment. The gains are favorably treated but not everyone can contribute to a Roth IRA. Very few 401 k plans offered by business are Roth plans
You have a point, you do... not sure it's that big of a deal. It's more of a big deal because of the draconian taxes the tyrannical government imposes. 50% tax on every dollar you fail to withdraw. That's unbelievable.
I guess where I got confused was this:
If you invested 100K and it grew to 1 million you would not be taxed on the 1ooK investment and the rest would be taxed at the lower capital gains rate of 15%
My understanding.... and I could be wrong... is that you have to pay taxes on the gain each year. Which adds up to thousands on thousands of dollars.
On any investment vehicle you only pay taxes on realized gains. So if you never cashed out stocks, bonds or mutual funds you would never pay taxes on them.
If I put $100K in a bank savings account, I have to pay taxes on the gain of that account each year.
Similarly, if I put that $100K into a mutual fund, and it gains 10% each year, every year I'll get hit with a capital gains tax of 15% on that gain, in addition to my regular income taxes. By the time I save up $1 Million in my mutual fund, I'll be paying $15,000 a year in Capital Gains tax.
If I work a $40K a year job, I could easily save up a Million dollars in a mutual fund. But by the time I got to that point, outside of a 401K, by the time I reached that amount, I'd be paying $15K in capital gains, in addition to my regular income tax.
However, if I put the same $100K into a 401K mutual fund, and it gains 10% a year, I pay zero taxes. When my mutual fund hits $1 Million, I'm still paying zero tax. Then if I have a 401K, I pull it out at my tax rate. If I have a Roth, I pull it out tax free.
I do grasp your point, that all things being equal, you would rather take the 15% capital gains rate, over the 35% income tax rate. But there is no way that someone earning $40K a year, would be able to take the yearly capital gains hit of $15,000 in addition to normal income tax. And if they sucked the yearly capital gains taxes, out of the mutual fund, they would never get even close to $1 Million saved up.
https://turbotax.intuit.com/tax-too...ax-Benefits-of-Your-401-k--Plan/INF22614.html
Distributions and Taxes
I could be all wrong about all of this, but that was my understanding.
Simple interest is counted as income. Appreciation in stock , bond or mutual fund shares is not.
If you saved 1 million dollars using after tax money in a private portfolio you would would not pay tax on the principle you withdraw only the gains and you would only pay that when you sold shares for cash.
Roth IRAs are a great tool and the best of the qualified plans IMO but if you leave a Roth to someone that person will be subject to required withdrawals.
In the long run 401 ks are actually better for the government than for the average Joe because the government gets more tax revenue out of them than any other type of investment.
So IMO if your employer offers a retirement plan with a match put in what you have to to max out all matching funds then invest in a Roth IRA if you qualify.m If you want to invest more than the Roth limits open up an investment account with a self service broker.