Xan wrote:
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.