While technically true, when you withdraw money from a 401k, wouldn’t the marginal tax rate on that withdrawal be figured as being the last dollar taxed (at the top rate)?

This is not how it works no. You are correct in saying that 401ks are always taxed at ordinary income but again, we have a marginal system so some could be taxed at 10%, some at 15%, it does not work out that they are automatically taxed at your top marginal rate, that is incorrect. Am I misunderstanding what you were saying? This was my point about using other vehicles such as the Roth IRA or Roth 401k, if you use them and then take distributions properly you have much control over your tax liability during retirement. I might also add that in 2010 there are some special rules about converting IRA’s to Roth IRA’s where you can spread the tax liability out over 2 years and there is not an income restriction to be able to do so.

If you really want to get technical, where people really start to get burned with the 401k is at age 70 1/2 especially if they don’t need the money. You take your RMD or you pay a monster tax penalty. Further, look at IRD rules when the IRA/401k owner passes and the money is inherited by someone other than the spouse. There are some estate planning tools you can use to offset these tax burdens but most people don’t know how to do it.

I would also suggest looking at long term studies of tax deferred accounts vs. taxable investments or accounts contributed to on an after tax basis such as the Roth IRA. Tax deferred accounts typically win out in the end. To make your study complete you would also need to factor in things such as the tax deduction one recieves for making pre-tax contributions to q-plans as well as any employer match or profit sharing they get for participation.

Don’t forget state taxes either.

“In our marginal system you aren’t paying the tax all at those specific rates”. While technically true, when you withdraw money from a 401k, wouldn’t the marginal tax rate on that withdrawal be figured as being the last dollar taxed (at the top rate)?

My main point: Withdrawals from 401ks are taxed at ORDINARY income tax rates, not preferrred capital gains taxes no matter what, or how long, they were invested in. And this should be factored into the story that BR posted.

Therefore investing in a 401k is a LONG-term bet on the future direction of tax rates.

Gentlemen (and ladies), make your bets!!

It seems to me that munis have been hot lately. Does Bill Gross smell another bailout?

I would say there’s a very good chance it has, in inflation-adjusted terms at least.

If it has in nominal terms – then better buy ammo, since that means we’ll probably be having a revolution within the next 10-15 years.

I would say there’s a very good chance it has, in inflation-adjusted terms at least.

If it has in nominal terms – then better buy ammo, since that means we’ll probably be having a revolution within the next 10-15 years.

S&P500 hits 400 some time before 12/31/10.

You can stack that up next to my 50 Yen prediction for 2009.

Cheers.

(which don’t have the income restriction like on regular Roth’s)

I understand your point, and it is a good one, but that is not exactly accurate when you are talking about the tax rates above. In our marginal system you aren’t paying the tax all at those specific rates, and the average annual w/d from a 401k is not going to be 33%. You need over 208k in taxable income as a married couple before you even trigger tax at 33%.

To your point though, this is why it is so important for people that qualify to utilize things like Roth IRA, or perhaps a Roth 401k (which don’t have the income restriction or regular Roth’s) if you are fortunate to work at a company that offers one. Also, roll the 401k to an IRA when you retire or separate employment. More investment options, more control, and you can control the tax w/h whereas a 401k requires a 20% Fed w/h.

I’d say to look at muni’s for tax purposes but I wouldn’t suggest buying muni’s to anybody right now.