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Using a 401(k) (or other tax-deferred retirement account) can be a fantastic way to save for retirement. However, who gets the most benefit out of using it? It turns out that the law of diminishing returns definitely applies to 401(k)s. Let me show you what I mean.
The Minimal Saver
Imagine a doctor who has never saved anything for retirement. He has a 33% marginal tax rate and his employer matches the first $10K he puts into his 401(k) each year. The first few dollars he puts into a 401(k) have a huge benefit for a number of reasons.
First, he gets the match. Instant 100% return on his money.
Second, since he isn't going to have much saved for retirement, he has a huge marginal utility of wealth for those saved dollars. While it doesn't make a big difference to go from $120K in retirement income to $125K, going from $30K to $35K might be the difference between Alpo and the organic food store.
Third, the smaller your tax-deferred retirement account, the less income you can take from it in retirement. Our income tax system is progressive, so the first dollars of income you have aren't taxed at all. In fact, for many low earners, they basically have negative taxes once you include all credits and government benefits. But at any rate, for our doctor with a current marginal rate of 33%, who can pull out much of his money at 0%, 10%, and 15% in retirement, there is a huge “tax arbitrage” there for him to take advantage of.
The Great Saver
Take another physician, however. He might have the same income as the first doc. However, he's a good saver and a good investor. He stuffs his tax-deferred retirement accounts full. In fact, he puts so much in there that his marginal tax rate falls to 28% during his peak earnings years. He saves a little money on the side as well, which he invests in real estate which he expects to kick out a pretty good income in retirement. He works until 70 or so and then finds out he's got a $7 Million tax-deferred IRA. Let's say that between Social Security and his real estate investments that he's got a taxable income of $120K. The Required Minimum Distribution on that is $252K and growing. If you only took the standard deduction, what would your marginal tax rate be? 33%. Putting money into your 401(k) at 28%, and taking it out at 33% is obviously less than ideal. Many insurance salesmen love to use this “retirement tax trap” possibility to scare people out of using a 401(k) at all, or worse, pulling all their money out of their 401(k)s, paying tax and penalties on it, and investing it into their favored investments. Obviously, most people and most physicians aren't going to have a retirement tax trap. But a few really good savers who don't take the time to get some tax diversification might.
Somewhere In Between
Of course, most physicians are going to be somewhere in the middle. The closer you are to the terrible saver, the more benefit you're going to see from putting money into your 401(k). The closer you are to the great saver, the more consideration you should be giving to things like Roth 401(k) contributions and Roth conversions. Tax-deferred savings is awesome, but it becomes less awesome the more you do it.
What do you think? What is the difference between your marginal tax rate now and what you expect to be able to pull your tax-deferred money out at? How will you decide when to do Roth conversions or make Roth 401(k) contributions? Comment below!
Interesting topic from an academic point of view. Tax diversification is certainly an important topic. Everyone wants to “win” by optimizing their retirement income and perhaps the super-saver might be kicking themselves for having a non-optimal tax portfolio. However, if you take a step back and look at the big picture, the super-saver has already won. If your income + RMDs are pushing you into such a high bracket, you clearly have “enough” for your retirement and you can worry about how to give it away. Not so in the first case (or if you are talked into sub-optimal investments).
I agree. So many retirement investors are obsessed with pre and post RMD taxation that they lose sight of the Total Net Return, that is the net of tax End Result. Bending over backwards to avoid taxes at the expense of the Pre Planned Total Return can result in less overall after tax money than incrementally paying tax on higher return investments than can deliver a larger after tax sum.
Yes, it’s important not to let the tax tail wag the investment dog.
You cannot put away too much money in ret plans. I am glad I did as rates were not what I had expected 40yrs ago. The tax deferred compounding is the eighth wonder of the world. I have no qualms paying now 25% federal tax on my distributions. Changing residency to Fla to avoid 5% state income tax and free from all estate taxes as well. You would not have these millions without IRA contributions so be content paying the taxes on money never taxed
You indeed can put too much money away in retirement plans, as the original post’s example shows. If your required minimum distribution kicks you to a higher bracket than your working years then you’ve reached that point: simple enough math.
He is saying that 40 years ago taxes were higher and for him (although) maybe not true into the future…it turned out great. Its impossible to know exactly what the future holds for tax rates, and its only recency bias that makes us believe it will be similar to today. It could be more or it could be worse. Lots of reasons either way, though I fall to the more side since at some point you would assume we have to make up for the last few decades of tax deficiency. Alas, I could be totally wrong.
I often wonder how to best structure things for maximum tax efficiency and as the savings grow I have to look at it further. In my deferred account I have almost all dividend paying stocks, reits, etc…and have good growth but no div types in the taxable. Hope to add an hsa next year and possibly switch my sep to a 401k so I can do some backdoors without the hassle. Its an interesting sport for sure.
Steve and Ken said it well. I feel very lucky to have to count tax diversification as one of my problems! I’m guessing this post is somewhat tongue in cheek as I would guess WCI doesn’t really believe in the idea that it is possible for anyone to save too much in their 401k. It is however a good idea to understand the pros and cons of traditional vs Roth IRAs and 401ks.
My vote: be that maxed out saver, put it Roth accounts. You don’t have to take required minimum distributions on the Roth IRA (you do on the Roth 401k). So, plan to spend from the Roth 401k first, and keep the Roth IRA for your heirs. If you run out of the Roth 401k funds or need extra, the Roth IRA is there for you.
Investopedia lays out the considerations:
http://www.investopedia.com/articles/retirement/06/moreonroth401k.asp
There is really little reason to leave money in a Roth 401(k) after retirement. Might as well just roll it over and make RMDs optional on that money.
But this isn’t tongue in cheek at all. The more you save, the less valuable that 401(k) benefit becomes compared to how valuable it was for the first dollar you put in there. That doesn’t mean there isn’t value there, just that there is less value. I certainly do believe you can oversave. If you are avoiding spending that would make you happy and end up dying with millions in the bank, you screwed up. You’ve got to find a balance in life. But this post is really about where you put the money you are saving and pointing out that if you’re really a supersaver, you might want to lean a little more toward tax-free accounts instead of doing all tax-deferred accounts, even in your peark earnings years.
Fair point about “saving too much”. On the flip side, one can also worry too much about tax optimization strategies and not enjoy the present either.
Not much of a debate for me personally. Without a Roth 401K option it’s simply about maxmizing whatever tax advantaged space we have including Mega-Backdoor, Backdoor, HSA and traditional 401K. Fortunatley, we have enough income and general frugality to do that and still do the things we want to do in the present (travel, etc.).
I am in the military and currently in the 25% bracket. Because of my expected pension alone I will continue to be the in the 25% bracket so Roth is more favorable for me regardless of how much I save. If my military income bumps me up a bracket or two between now and retirement then I can see switching over to traditional, but not at my current income level.
Good analysis and absolutely right. In fact, most military members should be doing Roth TSP and Roth IRAs, although spousal income has to be taken into consideration.
Even if your 401k withdrawals in retirement are equal to your income during your working years and the tax brackets are the same, you still come out ahead saving in a traditional 401k vs a Roth. This is because the tax savings on your contributions are all at your marginal tax rate, wheras your withdrawals are at your average tax rate. So, even with the marginal tax rate being equal, the traditional 401K is still superior.
The only time where the Roth might be superior for a high income earner and super saver, might be if he or she has substantial outside income such as from rental properties where that income puts them into a higher tax bracket to start with, then all RMDs will be at the higher tax brackets. But, as posters above have said, you’ve already won the game at that point.
Unless those lower brackets are filled up with something else (like a pension, rental property income, SS etc) or unless so much of your retirement income is in the high brackets that the average effective rate at which you withdraw the money is about what your marginal tax rate is now. Obviously this problem won’t apply to most, only to some super savers, and even most readers of this blog don’t qualify for that title.
Yes, you’ve won the game, but that’s no reason to throw away money that could go to causes you support rather than the general treasury fund of the government!
I feel like this a continuation of our debate on Roth 401K vs 401k discussion from a couple weeks ago 😉
The posts weren’t written that far apart, but both were written months ago. Not my fault the comments often stray into stuff I’ve written but not published yet! 🙂
True. My federal + state marginal rate is 40% now. Plan to move to a zero income tax state for retirement. I sure hope that my average effective rate in retirment isn’t 40%.
The illustration fails to account for the higher income physician (or physician family) who might be in a situation where his/her marginal rate approaches 50% (or more) due to state taxes, Obamacare levies, deduction phase-outs, etc. He/she is likely doing anything poosible to reduce current taxable income.
No, it certainly accounts for that. What it is saying is that if you’re saving a ton of money, you may be dealing with those state taxes, Obamacare taxes, phaseouts etc in retirement too! Most docs, of course, aren’t saving that much so it isn’t an issue.
Can you chart what the different tax brackets have looked like over time? There is no way to predict 20-40 years in the future, right?
Also, too funny: the Alpo dog food joke was perfectly placed with the jumping dog “Set for Life” in the email version.
Google is your friend:
http://www.theatlantic.com/business/archive/2012/04/how-we-pay-taxes-11-charts/255954/
and
http://www.supportingevidence.com/Government/FedIndividIncomeTaxRatesOverTime.html
Thanks, Matt. That second link is exactly what I was thinking about. I hear often about the golden days of doctor pay in the 1970s…but look at that 60+% tax rate!
My point is that taxes can go up or down. But it appears that the progressive step function has been in place for a while.
That second graph is actually quite sobering. Looks like we are near historic lows as far as income taxes on the higher income brackets go. Certainly makes one think about tax diversification for the future.
That graph is well-worth examining the details. For example, people who are in the highest bracket now would not have been at other time period. California, for instance, has a bracket for $1M+ that the feds don’t have.
This is very timely for me, as I have some major decisions to make this year. I turn 50 soon, so I can ramp up my 401k contribs to $24k. My employer also just started offering the “mega backdoor Roth” option. After counting my employers match toward the $53k total limit, I could potentially put $5-7k into a Roth that way this year.
I’m within a hair of 7 digits in the 401k now (Hmm, coincidentally, $24k shy!). I have a bit more than 7 figures in taxable accounts. I have ZERO in any type of Roth now.
At this point, I’m pretty sure I’ll continue maxing out the traditional limits. We’re in the 31-33% marginal now, but plan on being in the 15% marginal in retirement (MFJ), but could push into the 25% occasionally. I plan to retire at 53-55, and start massive Roth conversions.
I’d love to stay in the 15% bracket though. I know we can live a comfortable life in the 15% bracket (assuming about $90k in income before deductions). But counting Roth conversions, I’m not so sure.
I’ll also be juggling the taxable account which has some massive unrealized capital gains. I’d love to take most of them at 0% too.
So there are lots of moving parts to consider. But all in all, they’re good problems to have!
JJ, you have $1M in taxable and 401k but have you contributed to IRA at all?
Most will be in a lower tax bracket at retirement. I’m not sure that RMD will be an issue for most doctors. If you worry about RMDs, start converting your 401k plan balance into Roth right at retirement and delay social security until 70. Tax-deferred investing does makes some sense for those in the lower brackets especially if you get a match of some sort, but it is a nonlinear function that disproportionately benefits (in a good way) those who are in the highest tax brackets, and the savings they get will be significant (especially those in the 50% bracket for Federal + State). Chances are that those who are now in the highest brackets will be in a lower bracket during retirement. They will also max out their 401k, and even if they do have access do a Cash Balance plan, they will max it out at $2.5M, so they will still have to make significant after-tax investments.
Some might end up in a higher tax bracket, especially those who do not retire or who own very profitable businesses. The entire point is not to guess the future tax rate, but to accumulate enough savings and to diversify your tax liability as much as possible, and this will be an individual decision that will vary significantly depending on many factors. For one thing, not every one has access to a plan that can allow $250k a year tax deferred contribution, so having Roth and after-tax investments is always a great idea regardless of which tax bracket one is in.
I was alluding to this in my earlier response. Most high earning physicians (or physician families) who are in the highest tax brackets while they are working will be in a lower tax bracket in retirement. Alternatively, if the physician is drawing $500,000+ per annum off a nest egg of $12,500,000+ (4% rule) then I would say that this is not a bad problem to have.
Realistically, most physicians should be in a lower tax bracket and may have more control over their taxable income flow in retirement.
To me it seems more like a problem some one like WCI may have, rather than average physician. If average physician is lucky he is able to put away 50-53 K in 401/403. However some one like WCI who has two different jobs is able to put away upto 80- 100K in pretax. His 401K is going to be way over 5 million (still a good problem), while most average physicians will have less than 5 Million in their 401K. RMD for that should be under 200K. With inflation adjusted, 200K may not be a big amount then.
I don’t see diminishing benefits. A Roth 401k is still a 401k. The more you put into the 401k, the more you will have to convert from. Once converted, a Roth account dominates a taxable account in every way — except if you put taxable money into life insurance and die soon, in which case the life insurance agent is finally correct for once!
You’re right that conversions can change matters, although depending on your 401(k) and job it may be a long time before you can do that. While I agree with your general sentiment that a Roth is almost always a better option than a taxable account, there are some limited circumstances where that isn’t true-
1) If you need money before 59 1/2 and don’t want to deal with SEPP issues
2) When your investments lose money- can’t TLH a Roth
3) When you decide to borrow against your investments- can’t do that with a Roth.
At any rate, there is still a diminishing benefit as you go along, if for nothing else the marginal utility of additional wealth factor.
Harry, I agree with this with one possible exception. “Once converted, a Roth account dominates a taxable account in every way..”
Isn’t it true that each conversion to Roth has a 5 year “lock up” period before the funds can be withdrawn penalty free?
I’m potentially bumping up against that myself. Of course, the sooner I would get the clock ticking the better. But I think I still need to consider that each years conversion will have a penalty associated with it for a while.
Just plan ahead, convert early and convert often. Some call it a pipeline.
Interesting post, like anything with retirement there is so much to think about. I plan on retiring in an state without income tax, so that’s an extra 5-6% for me right there. Also, I’m maxing my 401K, backdoor roth, HSA and anything else I have and most of mine ends up in taxable anyways. Doesn’t seem like there is really any other option that I know of….anyone disagree??
Might have been a few comments lost off this thread today. Sorry about that. Had some technical difficulties upgrading the hosting. Hopefully the site runs faster and more reliably now!
Another consideration to make is that the super saver physician (Lets call her SSMD) is probably not going to work as a full time physician until the age of RMD.
Lets say SSMD, retires from full time medicine at 55 with $7 million in a rollover IRA and money in taxable accounts. SSMD travels the world for 5 years and has no earned income in these five years. Is SSMD in trouble and going to have to pay the 10% penalty to pay for her $700 brunch in Dubai?
Nope. There is this magical thing called the Roth Conversion. We will assume SSMD has her Roth for over 5 years now so she can withdraw her basis penalty free (important consideration). Since SSMD has no earned income, she can start her conversion paying 0% tax on the first $9225, 15% on $9225 to $37450, etc., paying well below her marginal rate in peak earning years for the conversion. Once you have converted this money to Roth, the converted amount is the new basis.
Thus, under Roth rules she can withdraw her basis tax penalty free (with do additional tax of course) into her checking account to be consumed as she sees fit. This strategy can allow her to burn down her enormous IRA account before she is required to at RMD age, she has money to spend – early withdrawal penalty free, and she is paying a much lower tax rate than the top marginal rate of her peak earning years.
Problem solved. Now only the docs crazy enough to work to standard retirement age despite being financially independent for 20 – 30 years need to worry about contributing too much to their IRA. This will be even fewer than those who save too much.
(WCI, it is time for you to talk about the Roth Conversion Ladder I described above in a post to enlighten everyone!)
In my comment above, it should read: “Lets say SSMD, retires from full time medicine at 55 with $7 million in a rollover IRA and no money in taxable accounts. SSMD travels the world for 5 years and has no earned income in these five years.”
Yes, that works, but so does the SEPP rule for covering the period between early retirement and SSMD. You didn’t explain where the money for the $700 brunches is coming from. You can just pull it out of the IRA and it will be taxed at very low amounts. Although I think it’s a little silly to only spend $50K or even $100K a year when you have a $7M IRA. Even at 3%, that’s $210K a year that you can safely pull out.
I agree that Roth conversions in that period of time between early retirement and age 70 is a good idea. As I recall, your idea of a Roth conversion ladder was doing Roth conversions every year, and using the 5 year old one for your spending. Why don’t you send me a guest post on it? It’s a clever idea.
It’s a more common topic for the early retirement crowd:
http://www.madfientist.com/traditional-ira-vs-roth-ira/
I think I need to do a little more fact checking but I think it is a useful concept. I am not aware of the SEPP rules so I can look into that as well. It can encourage docs to ruthlessly fund their IRAs without fear.
Steve F: You are exactly right. I got this idea from the Mad Fientist.
This may help: https://www.whitecoatinvestor.com/how-to-get-to-your-money-before-age-59-12/
Would there be a way to let the 401k grow and grow and then create a foundation that withdraws say 2.5% yearly to fund charitable acts directly from the 401k? I was planning on being a super saver and let the 401k grow into the millions slowly enjoying my life (I don’t want anything fancy). Then live off of taxable accounts from age 50-70. Then find a way to convert the 401k for charity. I suppose I would be the head of the charitable foundation and use the 2.5% yearly to donate to a good cause. I basically picked 2.5% so that gives ample space to grow based off of the 4% rule. When I pass away, my wife and children could head the foundation to continue contributing 2.5% forever. Could you point me in the right direction to set this up? Years in the future but still a thought.
That’s really easy, except the 2.5% part. After age 70 1/2 your withdrawals have to be at least the RMD amount, which starts at 3.8%. But if you give the entire RMD to charity, you don’t have to pay any taxes on it (although the Pease limitations probably apply, I’d have to look it up to be sure.)
How does taxation of contributions to a Roth 401/403/457 work when married filing jointly? In other words are the contributions taxed at the individual’s marginal rate and then additional taxes are due on contributions when the total couple’s income is considered at the end of the year (like the “marriage penalty”)?
IMD801 — I think you are confused. Roth contributions are not taxed. It’s simply after-tax money that grows and is withdrawn tax free.
I agree. All Roth contributions are after-tax.
Ah, silly mistake on my part. Thanks!
I don’t know that this is a real problem for a super saver like myself. For instance, if you are worried about the potential risks of the deferred tax payment at a higher bracket consider investing what you would have paid in tax for the roth option each year in a nontax-advantaged account.
So, if I invest that money and get an average 7% return on my $6105 (33% bracket) over 38 years it would come to $1,127,228.98 which would pay for a lot of your future taxes. If my 401k grows to 3.3M (same 7% return) over the next 38 years, that fund would pay my taxes for a very long time.
Yes, I have simplified things here, but you get my point.
Also, if can use the 401k to get myself into a lower tax bracket, then the advantage is increased even if I end up in a higher bracket later.
Actually, that decreases the advantage because the first dollar you put in the 401(k) might save you 33 cents in taxes and the last dollar may only save you 28 cents in taxes.
I meant that I could take that additional money saved from being in a lower tax bracket and invest it as well (more overall money making power over time from compounded investments).
Fantastic article. I have been thinking about this, but you put the ideas and numbers together in a clear and concise way. When a husband and wife both work and have profit sharing available, they can lock up over 10 million in traditional IRAs. At age 70, what is the most you want to have in there, based on our current tax law? It looks like a married couple hits the 28% bracket at 151k of income. Extrapolating that out and dividing by 3.8% (RMD at age 70) is 4 million.
I’m going to make a note to myself that having more than 4 million in my 401k at age 70 is the breakpoint, and anything more than that has very limited utility. Over 6 million becomes punitive with my current situation (stepping up to the 33% bracket). Obviously, this will change with tax laws and adjustment of tax brackets.
Yes, don’t forget the effect of inflation. $4 Million in today’s dollars will be a lot more in a few years.
We do not want to make blanket statements that sound reasonable but yet might not be applicable in every situation (and worse, be completely inappropriate for some).
For example, for those in the highest tax brackets, you’ll first need to do a tax-deferred vs. less in tax deferred + after-tax analysis to see which approach is better – it might turn out that you might have as much as 20% less money because of taxes if you decide to do the latter (this is a result for a very specific scenario, and the numbers can vary a lot depending on the assumptions). So having more money in the 401k might actually be a great idea. Thus, before doing the distribution analysis, you’ll need to see what makes sense as far as accumulation phase.
And even if you have $5M in a 401k plan, as long as you have $2M in after-tax assets, you can still do extremely well by converting your 401k assets to Roth, even if you end up in the highest bracket briefly during these years. You might be able to do better than leaving the money inside the 401k which can result in you being in the highest bracket for a lot longer. Doing Roth conversions from the time of early retirement (say at 60) until 70 can be a great way to cut your taxes in half on the future RMD distributions (and letting the Roth assets compound tax free). Whether to save more after-tax vs. tax-deferred is also not set in stone – there are various tradeoffs that unfortunately can not be reduced to a set rules of thumb.
I’m working on an excel calculator that allows me to compare various scenarios for the purpose of answering very specific questions, such as what is the best strategy to pursue – after-tax vs. tax-deferred, as well as how to split the assets between after-tax and tax-deferred, and there is no blanket answer – everything depends on many factors such as your rate of return, age of retirement, longevity, tax brackets, amounts saved, how much after-tax vs. tax-deferred assets you have, etc. So we can not simply state something that might be true for a particular scenario and use that as a rule to apply to all scenarios – this would be a very poor way to plan given how different the answers can be given all of the different variables we have to consider (and how the answer can vary even for the same scenario if there are any changes in our assumptions).
1) Great discussion! Sorry for the long comment, but I had to get it out 😉
2) I tend to look at the available options for whether or not to use traditional or Roth accounts with a different end goal than what is being discussed. WCI mentioned that it is possible to save too much by denying oneself and dying with millions in the bank. Sure, I agree. But what about having enough to be happy in retirement, dying with millions in the bank, and leaving those millions to one’s heirs TAX FREE. The discussion is focusing on the pros and cons of taxes for the supersaver and spouse. We should include multigenerational considerations to the equation (especially if we are talking about supersavers).
3) If you have the ability to completely fill all of your retirement savings buckets (401k, backdoor IRA, HSA, plus contribute to 529) the long term compounding stored in Roth accounts that could be available to heirs vastly outweighs the benefits of tax savings for the original saver. I appreciate the point of tax diversification because none of us can predict future tax law. My humble guess (and it can only be a guess) is that there is a greater chance for taxes in general to stay the same or INCREASE. Yes I MAY be better off by engineering when I pay taxes and at what brackets thus paying more or less. However, if one is lucky enough to be able to leave $200K to >$1MM in Roth accounts (in an IRA inheritance trust or otherwise properly stretched out), those heirs would be in a fantastic position, receiving substantial TAX FREE distributions for decades. Of course, it is our responsibility to keep those heirs grounded and teach them sound money management skills.
4) Another point to keep in mind is that if you are planning to make Roth conversions in the future, rather than using after tax dollars and contributing to Roth accounts now, the taxes on the conversions should be paid with money from outside the converted account. Otherwise, you are loosing a good deal of the benefit by reducing the converted balance that can compound over time. Therefore, it is necessary to have the tax payment in cash at the time of each conversion. Are you ready for that tax bill? I managed this with a good accountant for a parent with multiple conversions and although it was the right thing to do, it was confusing, a big headache, and required paying a accountant to get it right. For the above reasons, I feel that for the supersaver, it’s best to place money in the Roth he or she goes.
I’ve written about this concept before here:
https://www.whitecoatinvestor.com/building-wealth-across-the-generations/
While I agree tax-free distributions for heirs are better than tax-deferred ones, if your heir has a very low income, it seems silly for you to pay taxes at 33%+ to save them taxes at 10-15%.
Why would I assume they would have a very low income? I’m investing in a 529 so they can get a good education and be more likely to have a high income.
I didn’t say whether they would or would not have a low income. I said IF they had a low income, better for them to pay the taxes than you as far as lowering the overall tax burden. At any rate, if I had to bet on whether a doctor’s kids were more likely than not to have a lower income, I would take that bet all day long. It’s just pure statistics. Doctors outearn 99% of other people. Chances are very good that includes their kids.
Currently the 28% tax bracket is about $230K when married filling jointly. If someone wants to live off of their taxable account for 4.5 years, they can convert over $1million into a Roth IRA and pay upto the 28% tax. This is good if you are to retire in the 33%-39.6% tax brackets
I don’t recall meeting a retiree who said “I wish I hadn’t saved so much money.” Of course, as an intensivist, I also don’t recall anyone saying on their deathbed, “I wish I’d spent just a little more time at work.”
There’s an EXTREMELY small impact of the money you can put away that changes anything.
If the max you can put away pretax $18k/year (in your 401k), then AT MAXIMUM, there’s only $18k/year that could be in an otherwise lower tax bracket. Remember, if you make $241k, and the tax bracket changes at $231k (as it did in 2015) from 28% to 33%, you’re only paying 33% on the $10k difference between those two figures; the rest of your money was taxed at lower amounts. (10% from zero to $18k, 15% from $18k to $74k, and so on). [1]
The entire middle paragraph basically describes people who make between $231k and $249k, and are worried about JUST the tax on that $18k. I feel like it’s a bit of a distraction. There’s basically _no_ reason not to plow as much money as you can into your tax-deferred retirement accounts.
[1] http://www.forbes.com/sites/troyonink/2014/10/30/2015-federal-income-tax-rates-retirement-contribution-limits-kiddie-tax-gift-tax-exclusion-and-more/
You have to consider the alternative. There is one great reason not to plow as much as you can into tax-deferred accounts- Roth accounts. Many people are better off with a tax-free account contribution.
True, though in many cases the money is contributed from the top tax bracket, so your tax savings are that tax bracket plus your state tax bracket. So if you are in CA for example, the 33% might actually be 46%. If you are in the 28% bracket and live in a state without a state tax, obviously the advantage won’t be as great as for those in the 39.6% bracket (though I would argue that as long as you are in the 28% tax bracket, tax-deferred will win vs. after-tax). You also have to consider the tax difference now vs. in retirement. Chances are, someone in the 28% tax bracket might end up in the 15% bracket in retirement. Besides, we are talking about $18k or so with some matching – no reason not to diversify your tax liability, since presumably you’ll contribute a lot more to after-tax accounts.
In any case, I would refrain from making blanket statements without doing an actual side by side analysis. Once various assumptions are involved, because of compounding the results might not be as intuitive as one would think. There is such a thing as a ‘breakeven point’ which is a point where after-tax equals tax-deferred, and this point is different for different people (with variables that include tax bracket, rate of return, amount of contribution, time in the market, retirement age, etc).
In some cases the expense of a 401k plan can be so high that it might not make sense to accumulate large amounts in that specific account. That’s probably the only case where I’d worry about the plan. However, such plans should be replaced with lower cost ones.