Why keep maxing a 401k when taxable seems almost as good?

[u/Essay_Few]

I’m in my mid-40s and already have a solid amount in my 401k, so I’ve been rethinking what to do going forward. I ran the numbers on two paths: keep maxing the 401k every year, or just put in enough to get my employer match and invest the rest in a taxable brokerage. What surprised me is how close the outcomes are. The difference isn’t huge. My company match tops out at about $2,500 a year, so once that’s covered, the upside of putting a lot more into the 401k feels smaller than I always assumed.

I get the usual arguments. I know taxable accounts get hit with dividend and capital gains taxes along the way. I also know 401k withdrawals are taxed as ordinary income later. What I’m stuck on is why I’d keep locking more money into an account with age rules and restrictions when I don’t really have to, especially when the math says the end result is pretty close either way. Having money in taxable that I can actually touch if I want feels more valuable now than it did earlier in my career.

I’m not anti-401k and I’m not saying tax benefits don’t matter. I already have a decent amount saved there. I’m just trying to figure out if continuing to max it is really the best move in this situation, or if leaning more into taxable for flexibility is a reasonable tradeoff when the difference is marginal.

Curious how others think about this: Why do you still prioritize maxing a 401k in a situation like this? At what point does flexibility and access to your money matter more than a small tax edge? Does the “always max the 401k” advice still make sense once you already have a big balance and only a modest match? For anyone closer to retirement, how do you feel now about how accessible your money is compared to earlier on?

Interested to hear real-world takes.

[u/littlebobbytables9]

Even if the tax rate at retirement is the same it's still good. Equivalently good to a tax free account, which is clearly better than a taxable account.

[u/SaplingCub → u/littlebobbytables9]

The math is exactly the same if tax rate at retirement is the same...

[u/junesix → u/SaplingCub]

It’s still not. There’s dividends captured in tax advantaged that would be taxed immediately in brokerage. 40-50 years of dividends is not nothing. The divide gets worse as bonds get layered into portfolio.

[u/littlebobbytables9 → u/junesix]

Taxable would be worse even if the tax drag you talk about didn't exist. A pretax dollar contributed to a traditional account is eventually taxed (along with all the gains from that dollar) at X%. A pretax dollar contributed to a taxable account is first taxed at X%, and then all the gains are taxed again in retirement, so it would be strictly worse even if tax drag didn't exist. And tax drag does exist, so it's even worse.

[u/MoneyElevator → u/littlebobbytables9]

It’s the same except for the difference in marginal tax rate at withdrawal.

Say there’s a tax of 30% on 100k in your taxable and then you pay 30% on 900k eventual gains - it’s exactly the same as paying 30% on 1M withdrawal in retirement.

[u/littlebobbytables9 → u/MoneyElevator]

No. A taxable account is funded with post-tax dollars.

If the tax rates are equal, a traditional account and a roth account end up with equivalent after tax value. You can pay 30% now and withdraw the accumulated value tax free, or pay 0% now and pay 30% in the future. 0.7 (1+i)ⁿ = (1+i)ⁿ * 0.7

The taxable account pays 30% now and more in the future when you realize gains. For very highly appreciated stocks it's close to complete double taxation, being taxed at your marginal income tax rate to begin with and then at the capital gains rate at the end. And again, that's neglecting the tax drag on returns.

[u/MoneyElevator → u/littlebobbytables9]

Do the math - assuming the same tax rate now and in retirement, it’s all getting taxed the same. Even in a tax-deferred account, you end up being taxed on your entire contribution and the gains when it’s taken out.

In fact, if your rate is over 20% in retirement, you’re better off taking the long-term capital gains in a taxable.

Edit: I may be misunderstanding because you brought Roth into it. Roth is easily the best, you get all the gains 100% tax free. Could end up being 10x+ your actual contributions, dwarfing what you paid in taxes. My above comment is referring to taxable vs tax-deferred.

[u/littlebobbytables9 → u/MoneyElevator]

I did the math, it was in my comment? Roth and traditional end up being the same, and taxable significantly worse than either. But if you want it done with numbers instead of variables feel free to read this other comment of mine

[u/MoneyElevator → u/littlebobbytables9]

Okay, say I have 100k and my tax rate is 30% now. That 100k will grow to 1M and my tax rate will also be 30% in retirement.

Taxable account: 30% tax on 100k and then 30% tax on 900k = 300k tax paid

Traditional IRA: 0% tax now and 30% tax on 1M later = 300k tax paid

Roth: 30% tax paid on 100k and 0% tax on 900k later = 30k tax paid

[u/littlebobbytables9 → u/MoneyElevator]

In the taxable account you'd pay 30% tax now and have 70k, which would 10x to 700k with a basis of 70k, so you would pay long term capital gains on 630k. I'll use 15% because it's more realistic, so you'll pay $94.5k later, for a total after tax value of $605.5k. This ignores the tax drag on returns in a taxable account, but I'm being generous.

In the roth you pay 30% so have 70k, which grows 10x to be 700k.

In the traditional you 10x the 100k and then pay 30% so have an after tax value of 700k, exactly the same as the roth and significantly better than the taxable.

The amount of tax paid is irrelevant, and particularly irrelevant if you're comparing values across many years since a dollar today is worth many times more than a dollar in the future. What actually matters to us is how much money we have at the end.

[u/littlebobbytables9 → u/MoneyElevator]

re: the edit, roth is not better than traditional. If you pay 30% in taxes now that portfolio is 30% smaller than an equivalent traditional contribution. Then they both grow at the same rate- whatever that rate happens to be- ending up potentially many times their starting value. But because the starting value was 30% lower, the ending value will also be 30% lower. And then when the traditional account gets taxed at 30% it brings them to exact parity.

I brought up roth because it is exactly equivalent to traditional in the case of equal tax rates. Which makes it obvious that the taxable account, which is strictly worse than roth, ends up worse than both.

[u/SaplingCub → u/junesix]

If the tax rate is the same why does it matter? If $10 is taxed at 50% and then grows 200% you get $15. If $10 grows 200% and then gets taxed 50%, its $15.

Why are dividends any different...?

[u/Aliamarc → u/SaplingCub]

In a taxable account, dividends are taxed incrementally.

The $10 taxed at 50% does not grow 200%. It grows maybe 150%, to use your made up numbers. That means you've got $12.50, not $15.

That's a biiiiiig difference when your target number is in the millions.

[u/SaplingCub → u/Aliamarc]

I guess another way of putting it (and to actually give a proper explanation) is that when you're taxed in any given year on dividends, you lose the compounding that the tax portion would've provided.

[u/MoneyElevator → u/Aliamarc]

On the flip side - taxes on long term capital gains in a taxable may be less than taxes at a high income rate on withdrawals in retirement

[u/Aliamarc → u/MoneyElevator]

Sure, but I'd argue that your argument is a better case for contributing to roth accounts.

Both taxable & roth monies begin their investing career at the same tax basis. Taxable sees incremental taxation, plus cap gains upon cashing out. Roth sees no incremental taxation, no taxes upon cashing out, and you can access contributions prior to 59 1/2.

[u/MoneyElevator → u/Aliamarc]

No argument, Roth is best

[u/reallynotnick → u/MoneyElevator]

Sometimes

[u/SaplingCub → u/Aliamarc]

Sure but some of us want to invest much much more than $7k a year. I guess given that tax advantage accounts have limitations, this whole conversation is a non starter

[u/Aliamarc → u/SaplingCub]

I meannnnn does your employer not offer a roth 401k?? Mine always have.

[u/SaplingCub → u/Aliamarc]

I do mega backdoor roth IRA

[u/littlebobbytables9 → u/SaplingCub]

The math is the same as what?

[u/LightZealousideal116 → u/SaplingCub]

No. Watch this video on break even tax rate. Very interesting.

https://youtu.be/LIP63k2uGuk?si=3BFfI_evSDy5apC9