401k knowledge needed.

[OrangeCrush 86]

I get my 401k soon at my employer. I am 22 years old and looking at retirement options.

Anyways, I have done some research and there is 1 piece of information that I can't find.

How is deferring the tax a benefit to you? Does it benefit you at all?

I envision taxes being much higher when I retire vs. right now, so wouldn't deferring the tax screw you in the end?

If your employer matches a portion of what you put in that advantage is obvious; also the high limits are good. If my employer doesn't match though I might as well get an Roth IRA since I can't afford to contribute more than 4k a year anyways.

Thanks for the input.

[worduphomefry]

retire right now

[68GTO]

This is fairly simple.

• First, you need to understand the principle of compounding. The sooner you start saving in an interest bearing instrument the faster the money will grow in subsequent years. Let's say interest rate is 10%, for this example. Today you invest 100, next year it is worth 110 at the start. That $110 will add $11 this next year to $121, then the $121 grows by 10% to $142, etc...
• Secondly, in a 401K you are investing PRE-tax dollars which means you are getting an instant tax benefit as you don't pay taxes on them now. So, from your paycheck, again an example, you receive $100 but you are putting in 10% into your 401 K. That 10% = $10, which makes your taxable income fall to $90. So now, you are only paying taxes on $90 vs. $100 while saving the full value of the $10 to grow tax free! This is also good because the rate at which your investment will grow will outpace your tax rate growth resulting in a huge potential gain over time!
• Lastly, your company is willing to MATCH or GIVE YOU FREE MONEY. Um, TAKE IT and run with it. This only increases the base amount on which interest is calculated.

If you want a testimonial to wise investing when you are young, chat with NOTNSS! He's VERY wise about his financial future.

[Stormwalker]

I get my 401k soon at my employer. I am 22 years old and looking at retirement options.

Anyways, I have done some research and there is 1 piece of information that I can't find.

How is deferring the tax a benefit to you? Does it benefit you at all?

I envision taxes being much higher when I retire vs. right now, so wouldn't deferring the tax screw you in the end?

If your employer matches a portion of what you put in that advantage is obvious; also the high limits are good. If my employer doesn't match though I might as well get an Roth IRA since I can't afford to contribute more than 4k a year anyways.

Thanks for the input.

You somewhat answered your own question. If you envision your tax rate being higher later on (i.e. retirement age), then the Roth IRA would be the way to go. If you envision your tax rate being lower later on, then the traditional IRA would be the way to go. Keep in mind that the tax bracket you are in now, and the tax bracket you will be in at time of distribution will greatly affect the "tax rate".

If tax rate remains the same, there is a slight advantage to the Roth IRA.

This is a very simplistic explanation, and does not take into account the rest of your "financial picture". Also, this is a comparison of IRA accounts, not an IRA vs 401(k). One thing to note is the relatively new Roth 401(k), perhaps you should see if your employer offers that as an option if you think the Roth would be more beneficial.

This is not professional advice on which way to go, just a little bit of an explanation to how it works. You're welcome to get my number if you want to call me and talk about it more.

[CorinthiansBlackGT]

You want the best advice possible?

its simple, save what you can. The sooner your start the more you have to compound later.

[TurboX2]

This is fairly simple.

• Secondly, in a 401K you are investing PRE-tax dollars which means you are getting an instant tax benefit as you don't pay taxes on them now. So, from your paycheck, again an example, you receive $100 but you are putting in 10% into your 401 K. That 10% = $10, which makes your taxable income fall to $90. So now, you are only paying taxes on $90 vs. $100 while saving the full value of the $10 to grow tax free! This is also good because the rate at which your investment will grow will outpace your tax rate growth resulting in a huge potential gain over time!

I believe his question would be more like this....

Say the tax rate right now is 10%, then you are saving (not paying) the 10% on the 401k investment portion of your income. Lets say when you go to withdraw the money later in life you have to pay 11% tax on it. In that case you would have been better off paying the tax now and investing where you won't get taxed later. So the question is, how much tax will you pay on it later compared to the current tax rate? What tax rate do people pay right now who are withdrawing from 401k accounts?

This obviously is a question that doesn't include 401k investments that would have a match from the employer, you should always contribute up to the max match (instant 100% return). The question would really be should you contribute above that amount or would you be better off investing elsewhere...

[SpaceMan]

I believe his question would be more like this....

Say the tax rate right now is 10%, then you are saving (not paying) the 10% on the 401k investment portion of your income. Lets say when you go to withdraw the money later in life you have to pay 11% tax on it. In that case you would have been better off paying the tax now and investing where you won't get taxed later. So the question is, how much tax will you pay on it later compared to the current tax rate? What tax rate do people pay right now who are withdrawing from 401k accounts?

This obviously is a question that doesn't include 401k investments that would have a match from the employer, you should always contribute up to the max match (instant 100% return). The question would really be should you contribute above that amount or would you be better off investing elsewhere...

Don't worry. By the time you retire the tax rate will be 100% and it won't matter if the money was already taxed or not.

[OrangeCrush 86]

I believe his question would be more like this....

Say the tax rate right now is 10%, then you are saving (not paying) the 10% on the 401k investment portion of your income. Lets say when you go to withdraw the money later in life you have to pay 11% tax on it. In that case you would have been better off paying the tax now and investing where you won't get taxed later. So the question is, how much tax will you pay on it later compared to the current tax rate? What tax rate do people pay right now who are withdrawing from 401k accounts?

This obviously is a question that doesn't include 401k investments that would have a match from the employer, you should always contribute up to the max match (instant 100% return). The question would really be should you contribute above that amount or would you be better off investing elsewhere...

This is more what I mean. Since you have to pay taxes when you withdraw from a 401k, and the tax rate in the future will no doubt go up, wouldn't it be better to do something that has no taxes on the withdrawal?

Also, anyone know where to find the tax rate on 401k withdrawals?

[00Formula]

This is more what I mean. Since you have to pay taxes when you withdraw from a 401k, and the tax rate in the future will no doubt go up, wouldn't it be better to do something that has no taxes on the withdrawal?

Also, anyone know where to find the tax rate on 401k withdrawals?

It's questionable though as to whether your tax rate will be higher, at retirement your "income" may be less and put you in a lower tax bracket then you are now; however, at the same time you get a tax write off for IRA contributions so the immediate tax benefits can be argued either way.

The benefit to a 401K generally is the employer contribution but to 68's point the longer you hold off on paying taxes, the longer you make interest money from it.

So for example that 10% tax you could pay now and have no benefit from it or you could have that 10% invested for 30 years making you money before you have to hand it over to the IRS.

[SpaceMan]

It's questionable though as to whether your tax rate will be higher, at retirement your "income" may be less and put you in a lower tax bracket then you are now; however, at the same time you get a tax write off for IRA contributions so the immediate tax benefits can be argued either way.

The benefit to a 401K generally is the employer contribution but to 68's point the longer you hold off on paying taxes, the longer you make interest money from it.

So for example that 10% tax you could pay now and have no benefit from it or you could have that 10% invested for 30 years making you money before you have to hand it over to the IRS.

But interest isn't tax free. So whether you have $100 to invest and get taxed 10% upon withdrawal or $90 dollars post-tax to invest, the outcome will be the same.

The only thing that would change it would be change in growth vs. change in tax rate.

[OrangeCrush 86]

It's questionable though as to whether your tax rate will be higher, at retirement your "income" may be less and put you in a lower tax bracket then you are now; however, at the same time you get a tax write off for IRA contributions so the immediate tax benefits can be argued either way.

The benefit to a 401K generally is the employer contribution but to 68's point the longer you hold off on paying taxes, the longer you make interest money from it.

So for example that 10% tax you could pay now and have no benefit from it or you could have that 10% invested for 30 years making you money before you have to hand it over to the IRS.

So when you withdraw from a 401k it is just counted as regular income that you claim come tax time? So the amount of taxation would depend on how much you withdraw per year? Or does 401k money have its own taxation rate?

If 401k is counted as income, and the tax is determined by your tax bracket (just like if you held a job) then my question is answered.

I will do the 401k, then add a Roth IRA once I can afford it. I like the Roth feature that lets you take out your contributions with no penalty, as I like to have access to emergency cash. If you take anything out of a 401k then you are fucked.

I really hate putting money into retirement because if you die at 40 you just lost a shit load of fun money.

[00Formula]

But interest isn't tax free. So whether you have $100 to invest and get taxed 10% upon withdrawal or $90 dollars post-tax to invest, the outcome will be the same.

The only thing that would change it would be change in growth vs. change in tax rate.

The interest isn't tax free but for example over 30 years say you make an additional $60,000 in interest off the deferred tax. You aren't paying the government the deferred 10% + $60,000

What you are paying is the deferred 10% + 10% of the 60,000. So you still came out with an extra $54,000 due to the deffered amount.

[00Formula]

So when you withdraw from a 401k it is just counted as regular income that you claim come tax time? So the amount of taxation would depend on how much you withdraw per year? Or does 401k money have its own taxation rate?

If 401k is counted as income, and the tax is determined by your tax bracket (just like if you held a job) then my question is answered.

I will do the 401k, then add a Roth IRA once I can afford it. I like the Roth feature that lets you take out your contributions with no penalty, as I like to have access to emergency cash. If you take anything out of a 401k then you are fucked.

I really hate putting money into retirement because if you die at 40 you just lost a shit load of fun money.

Not completely true about the 401K withdrawal and penalty, yes if you do a full withdrawal you will have a 10% + tax penalty; however, there are certain situations where you can withdraw with no penalty and you can always take a loan up to 50% against your 401K with no penalty. If you take a loan out it's very low interest and when you pay it back it goes back in to your own retirement fund.

[OrangeCrush 86]

But interest isn't tax free. So whether you have $100 to invest and get taxed 10% upon withdrawal or $90 dollars post-tax to invest, the outcome will be the same.

The only thing that would change it would be change in growth vs. change in tax rate.

That is kind of what I was thinking. Also why I don't really get 68's point since no matter what you are paying a percentage of tax on the amount. Waiting until the end to pay the tax will result in a larger dollar amount going to taxes. However, that is if you were to take the lump sum from the account. From how I understand it now, say if you had low living expenses and you only withdrew $10,000 a year from you 401k and had no other sources of income you would save money as your tax bracket would be very low (claiming 10k a year) vs. say when you were making 50k a year at a job.

However, I imagine the difference would be close to nothing. The only real advantage is the employer matching your contribution.

[SpaceMan]

If you deposit $100 today, without it being taxed, and assume 10% continuously compounded interest, in 40 years the money would be worth $5459.82. If you got taxed 7% upon withdrawal it would be $5077.63.

If you got taxed on the money today, you would be taxed $7. So you would be depositing $93. Under the same scenario, in 40 years this would be worth $5077.63.

If you do the same with interest compounded yearly, monthly, etc. you get the same result.

That's all I'm saying.