What is the tax rate on a tax deferred 401k account?

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masonstone
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What is the tax rate on a tax deferred 401k account?

Post by masonstone » Tue Jun 04, 2019 11:49 am

How do you pay taxes on a tax deferred 401k account?

Let's say you're in the highest tax bracket at retirement and continue to be there in retirement. What would the tax rate be for your 401k account (Assume current tax rates)? Would both the principal and the capital-gain be taxed at the highest tax rate or would only the principal be taxed at the income tax rate and the capital gain be taxed at the capital-gain tax rate?
Last edited by masonstone on Tue Jun 04, 2019 12:06 pm, edited 1 time in total.

life in slices
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Re: What is the tax rate on a tax deferred 401k account?

Post by life in slices » Tue Jun 04, 2019 11:59 am

masonstone wrote:
Tue Jun 04, 2019 11:49 am
How do you pay taxes on a tax deferred 401k account?

Let's say you're in the highest tax bracket at retirement and continue to be there in retirement. What would the tax rate be for your 401k account (Assume current tax rates)? Would both the principle and the capital-gain be taxed at the highest tax rate or would only the principle be taxed at the income tax rate and the capital gain be taxed at the capital-gain tax rate?
All withdrawals/distributions from a 401k are going to be taxed as ordinary income. If you are already in the highest tax bracket then anything incrmentaly coming out of the 401k (principle and earnings) would be at that highest tax bracket

Silk McCue
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Re: What is the tax rate on a tax deferred 401k account?

Post by Silk McCue » Tue Jun 04, 2019 12:03 pm

Life in slices nailed the answer.

Once you are 70.5 you can make Qualified Charitable Distributions from an IRA (not 401k) and pay zero taxes on that up to $100k per year.

Cheers

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bertilak
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Re: What is the tax rate on a tax deferred 401k account?

Post by bertilak » Tue Jun 04, 2019 12:05 pm

Silk McCue wrote:
Tue Jun 04, 2019 12:03 pm
Life in slices nailed the answer.

Once you are 70.5 you can make Qualified Charitable Distributions from an IRA (not 401k) and pay zero taxes on that up to $100k per year.

Cheers
Could one do a rollover from 401k to IRA (tax free) and then do QCDs?
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker, the Cowboy Poet

Silk McCue
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Re: What is the tax rate on a tax deferred 401k account?

Post by Silk McCue » Tue Jun 04, 2019 12:06 pm

bertilak wrote:
Tue Jun 04, 2019 12:05 pm
Silk McCue wrote:
Tue Jun 04, 2019 12:03 pm
Life in slices nailed the answer.

Once you are 70.5 you can make Qualified Charitable Distributions from an IRA (not 401k) and pay zero taxes on that up to $100k per year.

Cheers
Could one do a rollover from 401k to IRA (tax free) and then do QCDs?
Absolutely.

Cheers

life in slices
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Re: What is the tax rate on a tax deferred 401k account?

Post by life in slices » Tue Jun 04, 2019 12:13 pm

Silk McCue wrote:
Tue Jun 04, 2019 12:03 pm
Life in slices nailed the answer.

Once you are 70.5 you can make Qualified Charitable Distributions from an IRA (not 401k) and pay zero taxes on that up to $100k per year.

Cheers
Great point!

noraz123
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Re: What is the tax rate on a tax deferred 401k account?

Post by noraz123 » Tue Jun 04, 2019 12:22 pm

masonstone wrote:
Tue Jun 04, 2019 11:49 am
How do you pay taxes on a tax deferred 401k account?

Let's say you're in the highest tax bracket at retirement and continue to be there in retirement. What would the tax rate be for your 401k account (Assume current tax rates)? Would both the principle and the capital-gain be taxed at the highest tax rate or would only the principle be taxed at the income tax rate and the capital gain be taxed at the capital-gain tax rate?
401K accounts are similar to regular IRA accounts. You've funded it with pre-tax dollars, so withdrawals are taxed at your tax tax rate. Meaning there is no capital gains tax for 401k withdrawals. It is all income, and taxed at your (marginal) tax rate.

If you expect your tax bracket to be higher when you retire (most expect it to be lower), a Roth 401k is likely a better choice. If you expect it to be the same, you are still better off in 401K vs. taxable due to tax-free compounding and deferred tax on dividends.

miamivice
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Re: What is the tax rate on a tax deferred 401k account?

Post by miamivice » Tue Jun 04, 2019 1:11 pm

Silk McCue wrote:
Tue Jun 04, 2019 12:03 pm
Life in slices nailed the answer.

Once you are 70.5 you can make Qualified Charitable Distributions from an IRA (not 401k) and pay zero taxes on that up to $100k per year.

Cheers
This might be true but is not related to the OPs question.

Silk McCue
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Re: What is the tax rate on a tax deferred 401k account?

Post by Silk McCue » Tue Jun 04, 2019 1:20 pm

miamivice wrote:
Tue Jun 04, 2019 1:11 pm
Silk McCue wrote:
Tue Jun 04, 2019 12:03 pm
Life in slices nailed the answer.

Once you are 70.5 you can make Qualified Charitable Distributions from an IRA (not 401k) and pay zero taxes on that up to $100k per year.

Cheers
This might be true but is not related to the OPs question.
It is related to the question because it has to do with the taxation of tax deferred retirement funds and they may be unaware that they can have a portion of those funds exempted from taxation.

There are still many people that are completely unaware of the very existence of QCDs. QCDs are brought up on posts regarding retirement withdrawal strategies on a regular and consistent basis on this forum as many users will never learn of them otherwise.

Cheers

rai
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Re: What is the tax rate on a tax deferred 401k account?

Post by rai » Tue Jun 04, 2019 1:24 pm

Silk McCue wrote:
Tue Jun 04, 2019 12:03 pm
Life in slices nailed the answer.

Once you are 70.5 you can make Qualified Charitable Distributions from an IRA (not 401k) and pay zero taxes on that up to $100k per year.

Cheers
So can value of charitable donations from IRA can be deducted from your income. Up to $100k/year? I mean not only not pay tax on donations but also deduct from your income?
"Life is what happens to you while you're busy making other plans" - John Lennon. | | "You say that money, isn't everything | But I'd like to see you live without it." - Silverchair

Silk McCue
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Re: What is the tax rate on a tax deferred 401k account?

Post by Silk McCue » Tue Jun 04, 2019 1:31 pm

rai wrote:
Tue Jun 04, 2019 1:24 pm
Silk McCue wrote:
Tue Jun 04, 2019 12:03 pm
Life in slices nailed the answer.

Once you are 70.5 you can make Qualified Charitable Distributions from an IRA (not 401k) and pay zero taxes on that up to $100k per year.

Cheers
So can value of charitable donations from IRA can be deducted from your income. Up to $100k/year? I mean not only not pay tax on donations but also deduct from your income?
Once you are 70.5. The QCDs are not itemized and don’t show up as income on your tax return, they are simply not taxed.

The checks must be cut direct to the charity. You can’t withdraw and then contribute.

Here is the Wiki for the details

https://www.bogleheads.org/wiki/Qualifi ... tributions

Cheers

retire2022
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Location: NYC

Re: What is the tax rate on a tax deferred 401k account?

Post by retire2022 » Tue Jun 04, 2019 2:16 pm

Also Christine Benz and Ed Slott on QCD recently June 3, 2019:

https://www.morningstar.com/articles/93 ... usion.html

fyre4ce
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Re: What is the tax rate on a tax deferred 401k account?

Post by fyre4ce » Tue Jun 04, 2019 2:32 pm

masonstone wrote:
Tue Jun 04, 2019 11:49 am
How do you pay taxes on a tax deferred 401k account?

Let's say you're in the highest tax bracket at retirement and continue to be there in retirement. What would the tax rate be for your 401k account (Assume current tax rates)? Would both the principal and the capital-gain be taxed at the highest tax rate or would only the principal be taxed at the income tax rate and the capital gain be taxed at the capital-gain tax rate?
Withdrawals from a 401k are taxed as ordinary income, same as if you earned it by working, although you won't owe payroll taxes on 401k withdrawals, whereas you do generally on earned income.

Let's say you withdraw $700,000 from your 401k in a given year, and that you're married and age >65. You would pay taxes according to the bracket structure that's in place at the time. If we used today's tax rates, you'd pay:

10% of the first $19,200 -> $1,920
12% of the next $59,750 -> $7,170
22% of the next $89,450 -> $19,679
24% of the next $153,050 -> $36,732
32% of the next $86,650 -> $27,760
35% of the next $204,150 -> $71,452.50
37% of the last $60,650*-> $22,440.50
Total taxes: $187,154, or about 26.74% of the $700k withdrawal

*$700,000 minus $27,000 standard deduction minus $612,350 top bracket threshold = $60,650 taxed in top bracket

Capital gains and qualified dividends are NOT taxed at reduced rates, as they would be in a taxable account. All withdrawals from a pre-tax 401k are taxed as ordinary income. There is no "principal" with a pre-tax 401k because nothing in the account has ever been taxed.

In this case, if you were to plan on withdrawing $700,000 each year (if you had a balance in the neighborhood of $700k / 4% = $17.5M), you could plan on Uncle Sam taking about 27% ($4.725M) of your account, leaving 73% ($12.775M) leftover for you.

As has been mentioned, if you are making a Traditional vs Roth decision, the marginal rate is what matters, not the average rate. If you're sure that you'll be in the top 37% bracket now and in retirement, you should generally prefer Roth accounts, because there's no tax rate arbitrage with a Traditional contribution (saving taxes at a higher rate and paying at a lower rate later), and you can effectively put more into a Roth account because after-tax dollars are worth more than pre-tax dollars.

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