I have an interesting ? about tax deferred savings(401s). If I start one now,and pay taxes on the money later,

Question

is there a chance the tax amount will be higher due to like government changes or something to that nature,than if just pay taxes on it now and find a equivelent interest bearing account to save it in? This would be an account without empl. match. or will the interest make up for any tax changes?(raises)

if my company doesnt offer any match would I be better off to go to my bank and open a roth?

so whatever tax bracket im in when I retire is what they will tax the 401 ?

Answer 1

There is a real chance that your tax bracket will be higher when you retire. This is especially true if you are young with many earning years ahead of you to save for retirement. However, even if your bracket at retirement is higher, your contributions to a 401k grow tax-deferred and compound. If you are young enough, this compounding effect can mean that you come out ahead even if you are taxed at a higher rate later.

At the same time, if you are in a low bracket now, it makes a lot of sense to contribute to a Roth IRA or Roth 401k. You will not pay income tax on qualified distributions of your contributions and the earnings from your contributions.

You can save money for retirement in after-tax accounts, but you will pay taxes each year on any earnings of your investment. Having some savings in after-tax accounts gives you flexibility in choosing how to withdraw your tax-deferred accounts, and when to take Social Security benefits. You can also benefit from lower tax rates on certain investment gains such as on the sale of stocks.

There are few absolute rules about saving for retirement. But one of them is, if you have a match at work, contribute to get the maximum match. After that, you can contribute more at work, or contribute to a Roth, or make after-tax investments.

Answer 2

If you defer the savings now, then you get a tax break now, but pay later. however, all of your earnings grow tax free until you take the money out - that might be 40 years from now!

If you're in a 25% tax bracket today, and a 25% tax bracket when you retire, then you would think that you could just put it in an interest bearing account and that would be equivalent.

You would be mistaken. Being able to not pay taxes annually ensure that you don't reduce the principal by taxes - thus the money grows faster.

If your company offers a Roth 401K, you might find that to be more advantageous - you don't get a tax break this year, however you will never pay taxes on the interest you earn off of the Roth.

Answer 3

Good answers above. One other thing to consider is that there are now Roth 401(k)s. Your employer may or may have not have modified your 401(k) to allow you to contribute to a Roth account. If so, you may be able to get the match and save money in an account on which the earnings will be tax free when withdrawn. The only downside is you don't get a deduction up front.

Jim Kirby, CPA

Answer 4

You really want that employer match if they're offering something. That beats all but the most risky investments.

If you are concerned about future taxes, and there are some situations where this would be valid, then maybe your employer offers a Roth 401k. Mine does, and I use it. They match like a regular 401k, but your contribution is not deducted from your taxable income now. But when you finally take the money out, it's tax free, both what you put in and any gain.

Answer 5

If you are concerned about that, a Roth IRA is a good way to go as withdrawals from it are not taxable.

However, I tend to think your tax will be less as your total taxable income is likely to be less. Best way to secure your retirement years in my mind is save as much and as early as possible and pay off the mortgage to your house. The combination of savings and lower monthly expenses will help you weather your golden years.