From: joetaxpayer 
Newsgroups: misc.invest.financial-plan
Subject: Re: Something I do not understand about 401(k)'s
Date: Thu, 20 Jul 2006 10:08:00 -0500
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BreadWithSpam@fractious.net wrote:

snip

> Here's an example:  Suppose you have a marginal tax rate
> of 20%, investments which grow at 10%/year (where the full
> 10% of the investment's growth is taxable - which is not
> necessarily realistic, either), and you have $1000 pre-tax
> to invest for 20 years, after which you spend the whole wad:
> 
> scenario 1:  Take the $1000, pay taxes now, invest in
> regular taxable account:
>   After taxes you have $800.
>   Each year, your investment grows by only 8% because
>     you pay 20% taxes on the 10% growth:
>   $800 * (1.08)^20 = $3729
> 
> scenario 2: Take the $1000, stick it in IRA/401k, let
> it grow, pull out the whole wad, pay taxes, spend:
>   $1000 * (1.10)^20 = $6727
>   Pay taxes:  $6727 * 0.8 = $5382
> 
> Wow, you say to yourself, that 401k/IRA is some powerful
> mojo.
> 
> Now, let's wank up the calculation by assuming that your
> 401k is a ripoff and they charge you 1% annually in addition.
>   $1000 * 1.09^20 = $5604
>   pay taxes:  $5604 * 0.8 = $4483
> 
> Note that even though your 401k was "ripping you off" to
> the tune of 10% of your annual gains, you still come out
> whoppingly ahead because geometric growth swamps linear
> proportions.
> 

Huh? Now you're doing what you suggested Jack did. Skewing the 
assumptions to suit your point.
You don't pay the 20% tax each year. You pay (more favorable) dividend 
tax rates on the dividends each year,
and the LT cap gain at the end of the scenario. In the 15% tax bracket, 
the dividends are 5% taxed.

So my numbers show a 5% tax on the small dividend each year, reinvested. 
Ther account grows to $5285 after year 20, $861 is from reinvested 
dividends. The gain taxed at LT rate is $3624, taxed at 10% or $362,
net $4923. (If you object to the 5% div tax rate, 10% will drop my final 
number to $4832).
The risk is that the saver will actually grow to a higher tax rate by 
the time they withdraw.

JOE