The Expert Podcast

It’s a fifty-thousand-dollar question in the new environment of interest rates and taxes: are 401K funds still a good idea for retirement planning and saving for retirement?

Here’s the thing: a 401K fund is a historically ubiquitous method of saving for retirement. Many companies have these plans as part of your employment, and many companies match your contribution. For example, if you’re an employee and you put in five thousand dollars a year, they match it with five thousand. It’s almost like free money—like you’re getting a raise.

The tax benefits are huge. The money that goes in is pre-tax. So, if you make a hundred thousand dollars a year and put ten thousand into your 401K (about $800 a month), you only pay income tax that year on ninety thousand. This means you save on taxes as well.

The question is, what are the ramifications later? As inflation is creeping up, but more importantly as it’s more likely that tax rates will be higher in the coming years, there may be some math that suggests a 401K might not be the best place to put money now.

This excludes the factor of your employer kicking in money, because that’s a whole separate calculation. Let’s assume that part’s taken off the table. If you put in ten thousand dollars into your 401K this year—forget about last year or next year, just this one year’s worth of money—you save on your taxes. Let’s say your tax rate is 20 percent. Ten years from now, when you go to take out that ten thousand, it likely grew. Let’s assume it doubled (it might do more than double in 10 years, but let’s stay conservative). Now it’s twenty thousand.

The tax rate, however, may have gone up to 30 percent, which is likely. Government funding for many projects is deficient, so many local, state, and federal governments are looking to add taxes. They may get rid of some deductions, close some loopholes, or simply raise the tax rate.

Let’s say now you take out that twenty thousand. You’ll need to pay tax on it when it comes out. If the tax rate is effectively 30 percent in 10 years, you’ll pay six thousand dollars in tax. Compare that to paying the tax on the ten thousand dollars the year you saved it, which would have been only two thousand dollars at a 20 percent rate. That’s a four-thousand-dollar difference in taxes.

Granted, there are other factors. The appreciation on the ten thousand is better than the depreciation on eight thousand. Maybe your employer’s match offsets part of it. However, when you calculate everything, make sure you take into account the fact that the tax rate will likely be higher, and the tax will be assessed on the higher value as it comes out—not the lower value that you put in.

Do the math. Calculate everything, including your employer match, and see which way is correct for you.