income tax calculation

Taxes are treated differently depending on the type of retirement account you have. This topic is discussed further in an article on Investopedia that goes over how withdrawals are handled with a 401k account. Here are some key takeaways from the article:

* Withdrawals made from 401(k) plans are subject to income tax at your current tax rate.

* During the years that they contribute, retirement savers enjoy a lower taxable income.

* Early withdrawals are subject to income tax as well as to a 10% early withdrawal penalty.

Davila, Damian. “Are 401(k) Withdrawals Considered Income?” Investopedia, 12 Jan 2021. <https://www.investopedia.com/ask/answers/110915/are-401k-withdrawals-considered-income.asp/>.

One thing that is mentioned in this article that sticks out to me is that withdrawals are subject to the current tax rate. This implies that if you think taxes are going to be lower in the future, it would be better to wait until later to pay the taxes. I suspect tax rates are probably going to be higher in the future, which means it might be better to consider using a Roth IRA for growth stocks, and a 401k for investments that aren’t going to grow as much but are also less risky (ie. bonds). So for example, if your goal is to create a classic 60/40 portfolio, you could put 40% of your savings into a 401k and then use that to invest in a bond ETF, and then put the remaining amount into a Roth IRA and use that to invest in stocks.

Aside from the tax differences between a 401k and a Roth IRA, another big difference is that with a Roth IRA, you can take your contributions (but not your earnings) out at anytime without paying a 10% early withdrawal penalty. In my case I’ve decided to use a Roth IRA and a traditional 401k, but it is good to keep in mind that taxes are treated differently with each type of account, and there are advantages to and disadvantages to both.