Last week, I happened to see an item on CNBC about an article to be printed in the weekend Wall Street Journal claiming that, for people within 5-10 years of retirement, it would be better to save in a taxable account than in a tax-deferred account (IRA or 401(k)) because the higher tax rate when you withdraw from the tax-deferred account (35% rather than 15%, in their example) would put you behind what you’d gain from the deferral.
I tried out the math, and it didn’t make any sense — if you had, say, $10,000 available, the advantage of investing the full $10,000 instead of $6,500 after-tax far outweighted the lower tax later on.
So I asked my broker, who sent me the article (here (behind a paywall, of course). And, buried about 2/3 of the way through the article, was the explanation:
This example assumes that the executive can afford an upfront tax hit…to put $100,000 in a taxable account, she would have to earn about $154,000.
Well, gee…comparing putting aside $154,000 versus $100,000, it’s not too surprising that the bigger allotment would produce better results — that extra $54,000 buys you a lower tax rate later on. But you’d still come out better if you could put the whole $154,000 in pre-tax.
There are, of course, other considerations, such as the fact that money in a taxable account isn’t subject to minimum distributions — but nonetheless, having to kick in an extra 54% to get the same results is significant.
Amazingly enough, this article wasn’t even on the editorial page, where facts are routinely ignored. It was in the “Personal Journal” section. Consider yourself warned.