Save to Retire: Pre-tax, After-tax or Roth?

Optimal Tax Environment to Save for Retirement (continued)

It’s not sound because it did not consider: “MTR when receiving distributions may impact tax later.”

Compare Pre-tax 401(k) to After-tax Savings considering distributions from the Pre-tax 401(k) at: 25% MTR, 15% MTR and 33% MTR 

Age Pre-tax 401(k):
$10k/5 yrs 7%
25% MTR Aft-tax
Distribution
15% MTR Aft-tax
Distribution
33% MTR Aft-tax
Distribution
After-tax Savings:
$7.5k/5 yrs @5.68%
After-tax
Distribution
40 $10,350       $7,713  
41 21,425       15,864  
42 33,274       24,478  
43 45,953       33,581  
44 59,520       43,201  
66 $263,698       $145,661  
83 255,942 -19,661 -22,283 -17,564 153,935 -13,131
84 0 -19,661 -22,283 -17,564 0 -13,131
Total   $353,901 $401,088 $316,152   $236,365

Commentary  In the “pre-tax” environment, the individual receives a higher amount if her MTR remains static, dereases or increases.  I guess all the hype about the “Magic of Compounding Interest” in a pre-tax environment is true, but does that mean that “pre-tax” is the optimal environment to save for retirement?  Consider saving in an after-tax Roth environment to see what those numbers reveal… 

After-tax Roth 401(k): Contribute $7,500/year for 5 years (age 40-44); Distribute 18 equal payments (age 67-84):

Age After-tax Roth
401(k) Contribution
Account
Value @7%
Tax-free
Distribution
40 $7,500   $7,763  
41 7,500 16,068  
42 7,500 24,956  
43 7,500 34,465  
44 7,500 44,640  
45-66 0            $197,774      
67-83   191,957     -19,661
84 Last Payment 0     -19,661
Total     $353,901

Compare Pre-tax 401(k) to After-tax Roth 401(k)11111

Age Pre-tax 401(k): $10,000
for 5 years @7%
After-tax
Distribution
After-tax Roth: $7,500
for 5 years @7%
Tax-free
Distribution
40 $10,350     $7,763  
41 21,425   16,068  
42 33,274   24,956  
43 45,953   34,465  
44 59,520   44,640  
66 $263,698               $197,774              
83 255,942             -19,661 191,957             -19,661
84 0             -19,661 0             -19,661
Total   $353,901   $353,901

Commentary Perhaps you are surprised (I was) that the individual receives the exact same outcome saving $10,000 in the pre-tax 401(k) or $7,500 in the after-tax Roth 401(k); however, this outcome assumes that the individual’s MTR remains static at 25% when receiving distributions. What is the outcome if the MTR is lower or higher?

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Copyright © 2009 Barry R. Milberg   All Rights Reserved

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