Tax. deferred accounts vs. long term capital gains?

I am reading that tax deffered account like 401K aren't so great because you end up paying ordinary income tax rates on the withdrawls. Is it better then to invest your money directly in stocks and just pay the long term capital gains tax rate, 15%?

I have already maxed out my 401k and IRA's . Now I want to max out a SEP for a side-business. But should I just invest the money in stocks directly? Which is better?

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Reply to
oprah.chopra
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You will end up with more with 401K for the same investment if your tax brackets don't change. The initial tax deferral helps a lot.

You will later be able to convert the 401K to an IRA and then to a Roth.

It's good to have direct investments in the stock market for flexibility and those things that aren't available in a 401K.

-- Ron

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Reply to
Ron Peterson

Politics aside:

At least one candidate for president has said that if he is elected he will raise the capital gains tax to 28% -- so the present 15% staying that way is not a sure thing.

Reply to
Ernie Klein

And given that it's near guaranteed the Bush tax cuts aren't going to be renewed/extended, that 15% is going to 20% with virtual certainty in 2010 or 2011 when those tax cuts sunset (and dividends will go back to being pure ordinary income, too).

-- Rich Carreiro snipped-for-privacy@rlcarr.com

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Reply to
Rich Carreiro

Obama in the March debate and elsewhere has said he "certainly would not go above... 28%." Then the debate moderator challenged Obama with the oft-repeated claim that, when CG tax rates drop, tax revenues go up. (There is some evidence to support this.)

It is not "near guaranteed," since McCain may very well win in November, and he supports continuing the rate at 15%.

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Reply to
Elle

According to the civics classes I took in grade school, the House and Senate originate bills, not the President.

Given the current composition of the House and Senate (let alone the likely post-Nov 2008 composition), it doesn't matter what Mr. McCain wants should he win, since no bill to extend the 15% rate and qualified dividends treatment is going to make it to his desk.

-- Rich Carreiro snipped-for-privacy@rlcarr.com

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Reply to
Rich Carreiro

My back-of-envelope calculations suggest that this is a difficult question to answer. There is no question that even if capital-gain tax rates are substantially less than ordinary income tax rates, you are better off with a tax-deferred account if you wait long enough. The trouble is that the definition of "long enough" varies wildly with the particular situation. As an obvious example, if regular income tax rates are 25% and capital-gains rates are 15%, then you pay an extra 10% on all your earnings if they're in a tax-deferred account. However, in the tax-deferred account, those earnings compound tax-free until you withdraw them, which means that the extra money you make will eventually outweigh the difference in tax rates.

How long you have to wait depends on how your investments perform, when you need the money, what happens to future tax rates, and lots of other imponderables.

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Reply to
Andrew Koenig

If you can buy _perfectly_ tax-efficient stocks (ie. which throw off no dividends and only hold cap-gains) and you never re-balance, and you don't require a portfolio which holds other assets (ie. bonds), you *could* be right - that instead of a 401k, you may come out ahead with stocks in your taxable account.

But that's a lot of ifs. And doesn't take into account any possibility of long-term cap-gains rates (or, similarly, income rates) changing.

The fact is, though, that most diversified stock-holding portfolios *do* throw off currently taxable income - cap gains from rebalancing, taxable dividends, and when the portfolio is balanced with some fixed-income (which is a good idea for most portfolios, even if only as little as 10 or 20%) - a tax-deferred account (or tax-free account like a Roth, especially) comes out well ahead.

In addition, having the assets in a 401k or IRA adds additional layers of protection against creditors, and may not be considered as assets you have when they compute college financial aid calculations.

In the end, there are arguments for *both* classes of accounts - taxable *and* tax-favored (whether deferred or Roth-ish).

Reply to
BreadWithSpam

Adults who study actual politics know there is ongoing back-and-forth between the two houses and the President. One way or another, the President often does have his/her legislative ambitions realized. There are strong arguments that raising the cap gains tax is deleterious to the economy and tax revenues. I won't bet right now on what will happen.

To the OP: This past week another regular here and I have been discussing asset location. Depending, one strategy you may want to employ is ensuring all your bond allocation is in your 401(k). For many people, non-muni bonds are the least tax efficient (generally being taxed as ordinary income) and so are served best through tax deferral in a Trad IRA or 401(k). The following article is a good read on the subject:

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Reply to
Elle

This has already changed back and forth three times in my savings career. The principle of "tax diversification" suggests investing in different tax vehicles to weather changes.

Anyways, many of longer term investors have had to invest in alternative savings. Tax deferred limits were rather small until the mid-1990s, and too small now for six figure incomes. Its recommended one save 15% for all needs.

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Reply to
rick++

You can change your investments inside a tax-deferred account without penalty. If a stock goes sour and you sell it, you get hit with taxes. You want stomething very diversified and tax efficient like a broad index fund.

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Reply to
rick++

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