Maxing Out 401(k) Contributions

[dualstow]

DualStow, Sophie: which thread was it that discussed overdeferrence? Thank you!

Very sorry for the late reply, W. I just saw your question, as I haven't visited this thread for a while.
There have been threads in this forum or bogleheads or both called "Possible to have too much in tax deferred?" or something like that.

[williswine]

Thank you dualstow, I will use your quote as a search keyword.

[Libertarian666]

Sophie, I think you're understating the advantages of tax-deferral.  The concept of "over-deferring" is a fascinating one, and I do believe that it's possible, but deferring isn't as bad as you're making it seem.

First, the list of exceptions to the early withdrawal penalty is fairly substantial, and covers many of the scenarios where you might need the money, like disability and medical expenses, and even first-time home buying (not sure why that one's there...)
http://www.irs.gov/publications/p590/ch ... 1000230905

More importantly, I don't think that having all earnings taxed as ordinary income instead of capital gains is a bad thing.  Let's say you're 50, in the 28% bracket, and you retire at 70, still in the 28% bracket.  Let's say the PP (or whatever you're investing in) doubles in that time.

If you don't defer the taxes, then you pay $280,000 in taxes up front.  You're investing $720K.  You have $1.44M when you retire, at which point you pay $108K (15% of the $720K gain) in taxes.  You're left with $1.332M.

If you defer the money, then you're investing the whole $1M, you have $2M at age 70, and you pay 28% on it at that time.  You have $1.44M after taxes.  That's $108K more than the non-deferral scenario.  The difference is the capital gains taxes which you NEVER had to pay.

Apart from the issue of the rules changing, tax deferral can only make you better off.  It's not a matter of losing the sweet capital gains rate in exchange for a hopefully lower tax bracket; it's never having to pay capital gains taxes at all.

Also, the non-deferred scenario was a best-case presentation of no buying or selling (rebalancing) during the 20-year period.  You might have to pay capital gains taxes multiple times.

It's not that simple, as higher regular income has more than one drawback. You will pay taxes on 85% of your Social Security, you may have to pay higher Medicare premiums, there may be AMT issues at certain income levels, and that's just the beginning. I haven't even mentioned the possibility of leaving appreciated securities to your heirs, who also won't have to pay capital gains taxes due to the step-up in basis at death.

Also, as far as paying capital gains taxes, what if you can realize most or all of those in the 0% bracket, as can be done with up to $77K taxable income for a married couple?

These things are VERY complicated and need significant advance planning to optimize them.