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Russell says: "The money you invest in your 401k or 403b plan grows tax-deferred and you are not taxed on this money until you actually take a distribution, which is normally at retirement. This means that if you contribute a total of $50,000 to your plan and over time it grows to $100,000, that accumulation is not reported on your annual income tax and you therefore do not have to pay capital gains tax on that $50,000 in growth. Assuming that scenario, you saved tax dollars by contributing to the plan while you were working, and your retirement asset grew without having to pay capital gains taxes while it accumulated. Now that's a nice benefit don't you think?"
Russell: Whether or not an investment is pre or post tax the gains are not subject to income tax until withdrawn. But unlike a post-tax investment where the gains are subject to income tax at the much lower capital gains rate the gains (as well as the contributions) in a pre-tax investment are subject to income tax at the higher ordinary income tax rates. You may want to correct your article as published on your blog.
Peace and hope,
Joel L. Frank
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Russell's Blog A quote from Russell
#2
Posted 10 July 2006 - 10:41 AM
Russell,
Didn't your compliance department catch the error in its review?
Didn't your compliance department catch the error in its review?
Mark Fischer, CFA
#4
Posted 13 July 2006 - 12:24 AM
Assuming 25 years ago...
Jack and Jill decided to invest $10k/year into their retirement accounts.
Jack is investing in a mutual fund portfolio, whereas Jill is investing in a variable annuity.
Now lets say they both received an average annual return of 12.5%.
Today Jack's account has over $923k in it
Today Jill's account has over $1.445mil in it, due to tax deferral
If Jack and Jill now want to take out 10% from their respective nest eggs each year and pay 15% and 20% respectively in income taxes on those withdrawals
Jack will net approx $78k and Jill will net approx $115k
Jack and Jill decided to invest $10k/year into their retirement accounts.
Jack is investing in a mutual fund portfolio, whereas Jill is investing in a variable annuity.
Now lets say they both received an average annual return of 12.5%.
Today Jack's account has over $923k in it
Today Jill's account has over $1.445mil in it, due to tax deferral
If Jack and Jill now want to take out 10% from their respective nest eggs each year and pay 15% and 20% respectively in income taxes on those withdrawals
Jack will net approx $78k and Jill will net approx $115k
This post has been edited by kaopats: 13 July 2006 - 12:25 AM
#5
Posted 13 July 2006 - 06:23 AM
I think this came from my Money, Banking and Financial Markets prof, slightly modified by me.
Three guys are stranded on a desert island, a physicist, an engineer and a annuity salesman. They have no food, except for cases of canned beans that they were transporting on the ship.
They are pondering how to open the cans. The physicist says, I have it. We will build a fire and heat the cans. The liquids in the can will turn to gas and expand. Eventually the can will be ruptured.
The engineer said that is a good idea, but the beans may end up being burnt from the heat. I have a better idea. I will sharpen a rock and attach it to two sticks. The sticks will act as a lever and force the sharp rock into the lid and puncture it.
The annuity salesman says, you guys are making this much too difficult. First, let's assume we have a can opener.
Three guys are stranded on a desert island, a physicist, an engineer and a annuity salesman. They have no food, except for cases of canned beans that they were transporting on the ship.
They are pondering how to open the cans. The physicist says, I have it. We will build a fire and heat the cans. The liquids in the can will turn to gas and expand. Eventually the can will be ruptured.
The engineer said that is a good idea, but the beans may end up being burnt from the heat. I have a better idea. I will sharpen a rock and attach it to two sticks. The sticks will act as a lever and force the sharp rock into the lid and puncture it.
The annuity salesman says, you guys are making this much too difficult. First, let's assume we have a can opener.
This post has been edited by fischermh: 13 July 2006 - 06:23 AM
Mark Fischer, CFA
#6
Posted 13 July 2006 - 10:02 AM
QUOTE(kaopats @ Jul 13 2006, 01:24 AM) 
Assuming 25 years ago...
Jack and Jill decided to invest $10k/year into their retirement accounts.
Jack is investing in a mutual fund portfolio, whereas Jill is investing in a variable annuity.
Now lets say they both received an average annual return of 12.5%.
Today Jack's account has over $923k in it
Today Jill's account has over $1.445mil in it, due to tax deferral
If Jack and Jill now want to take out 10% from their respective nest eggs each year and pay 15% and 20% respectively in income taxes on those withdrawals
Jack will net approx $78k and Jill will net approx $115k
Uh, aren't you missing something here? If Jack invested in a mutual fund 403b account, his money, too, will accumulate on a tax deferred basis.
Not only that, the fees from a no-load group such as Vanguard will be substantially lower than they would be for a variable annuity pitched by a commission-receiving salesman. So in reality, Jack's account will be larger than Jill's.
The salesman, of course, would be far better off if the client purchased a variable annuity.
If you are a salesman and you do not realize that mutual fund 403b accounts accumulate on a tax-deferred basis, that is pretty pathetic. If, on the other hand, you do know this, and you know that you are stating something that is false, that is even worse.
#7
Posted 13 July 2006 - 02:21 PM
Consider the following more realistic comparison:
1) 10K each year for 25 yrs.
2) 12.5% return (which is too high, but you used it)
3) Variable annuity fees of 2%. This is pretty conservative. NEA's Baloney Builder, for example has an M&E charge of .90, so with other fees, 2% is way too low.
4) 403b mutual fund fees of .2%, which is what Vanguard charges for many of its funds.
After 25 years:
The Baloney Builder variable annuity returns $1,119,915
The Vanguard 403b mutual fund returns $1,487,789.
(Source: http://www.dinkytown.net/java/Retire403b.html)
This is a difference of >300K.
I understand that variable annuities are great for commission-based salesmen, but for the life of me (pardon the pun), I can't understand why an investor would want one. Your example ignores the fact that one can invest directly into a 403b mutual fund without using a variable annuity vehicle.
1) 10K each year for 25 yrs.
2) 12.5% return (which is too high, but you used it)
3) Variable annuity fees of 2%. This is pretty conservative. NEA's Baloney Builder, for example has an M&E charge of .90, so with other fees, 2% is way too low.
4) 403b mutual fund fees of .2%, which is what Vanguard charges for many of its funds.
After 25 years:
The Baloney Builder variable annuity returns $1,119,915
The Vanguard 403b mutual fund returns $1,487,789.
(Source: http://www.dinkytown.net/java/Retire403b.html)
This is a difference of >300K.
I understand that variable annuities are great for commission-based salesmen, but for the life of me (pardon the pun), I can't understand why an investor would want one. Your example ignores the fact that one can invest directly into a 403b mutual fund without using a variable annuity vehicle.
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