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scripta;19780743 said:That $25K earning 6% over 15 years will still be exactly 25% of the account balance. So if you withdraw your balance at a 25% tax rate, all those gains will go to the government.

The advantage of pre-tax retirement savings is not the fact that they grow tax free, but that you will most likely be able to withdraw them at a lower tax rate than when you contribute. That's all. There's a huge discussion about this every time someone asks whether to put their money in pre-tax or after-tax accounts. If you are going to retire rich (not in terms of assets, but with high taxable income that puts you in a higher-than-your-current tax bracket, or you simply expect tax rates to go up on everyone and you'll end up in a higher tax bracket than now), then it may be advantageous to invest in after-tax accounts.

In 2000, I sell identical positions in a tax sheltered and non-sheltered account, both of which have gains of 100,000.  I have $100,000 in the tax sheltered account.
In 2001, I pay tax of 25,000 from the sale in the taxable account.  I have $75,000 in the taxable market account.
In 15 years, at 6%, the $100,000 grows to $239,655.82.  Pay 25% tax  ($59,913.95) leaving $178,741.86 from the tax sheltered account.
In 15 years, at 6%, the $75,000 grows to $179,741.86 from the taxable account (not sure why it isn't exact, probably a rounding error).  
So the issue is simply whether the capital gains rate (25% in the above hypothetical) will be greater (historically unlikely) or lesser (historically the case) than the income tax rate at the time of withdrawal?  

Of course, if this is done in a Roth IRA, then there is no 25% tax in the sheltered account and then you have a lot more money, no?

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DavidScubadiver said:   In 15 years, at 6%, the $100,000 grows to $239,655.82. Pay 25% tax ($59,913.95) leaving $178,741.86 from the tax sheltered account.
In 15 years, at 6%, the $75,000 grows to $179,741.86 from the taxable account (not sure why it isn't exact, probably a rounding error).
It is exact -- 239655.82 - 59913.95 = 179741.86.

DavidScubadiver said:   So the issue is simply whether the capital gains rate (25% in the above hypothetical) will be greater (historically unlikely) or lesser (historically the case) than the income tax rate at the time of withdrawal?Yes. If any interest paid on the 401k loan is treated as an after-tax contribution so that only gains are taxed at withdrawal, you'll pay income tax on those gains. And I'm not sure if it's treated that way or if it's treated as a pre-tax contribution, in which case you might pay income tax on the interest twice (once before you paid it to yourself, once at withdrawal).
In a taxable account you only owe capital gains taxes on the capital gains (not the original amount), and as you said, capital gains taxes are usually lower than income taxes.

DavidScubadiver said:   Of course, if this is done in a Roth IRA, then there is no 25% tax in the sheltered account and then you have a lot more money, no?Not with your example. This is actually what I had in mind in the first place. Assume you have $7333.33 in pre-tax income to contribute:

401k: contribute $7333.33. After 15 years at 6% the balance is 17574.75. Withdraw the whole balance, pay 25% income tax, keep $13181.06 (assumes total income puts you into the 25% bracket).
Roth: pay 25% tax on that $7333.33, contribute the rest ($5500) to Roth IRA. After 15 years at 6%, the balance is exactly the same as above $13181.07 and no tax is due (the $0.01 difference is due to rounding).

This illustrates that there's no advantage to "tax free growth" in a 401k when compared to a Roth IRA if your effective (attributed to the 401k withdrawals) tax rate at retirement equals your marginal tax rate at contribution.

However... if you could take a loan from a Roth IRA and pay yourself interest, then you'd have more money simply because you'd be contributing more after-tax money to an after-tax tax-advantaged account. So the lesson is instead of taking a 401k loan and paying yourself interest to inflate that balance, just backdoor and mega-backdoor Roth IRA!

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Thanks, Scripta. If you take the loan from the 401(k), the "interest" you pay back is paid back after tax, and of course, is taxed again upon eventual withdrawal. That was the reason I never took the loan out (and because I had no need of it).

Because my math skills are not so great here, I will ask you a somewhat related question -- Every year I backdoor into my Roth IRA. This is a sound decision regardless of whether I am going to be in a higher or lower bracket when I withdraw, correct? (Assume I have maximized my tax sheltered contributions).

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DavidScubadiver said:   Thanks, Scripta. If you take the loan from the 401(k), the "interest" you pay back is paid back after tax, and of course, is taxed again upon eventual withdrawal. That was the reason I never took the loan out (and because I had no need of it).

Because my math skills are not so great here, I will ask you a somewhat related question -- Every year I backdoor into my Roth IRA. This is a sound decision regardless of whether I am going to be in a higher or lower bracket when I withdraw, correct? (Assume I have maximized my tax sheltered contributions).
With that assumption -- yes. Qualified distributions from a Roth IRA are not included in gross income. Assuming some idiots in government don't take away the benefits of Roth

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