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The 401(k) continues to be a hot topic. So, I thought I'd summarize the points I talk about in one of the seminars I do.

The Three Reasons Why Not to Do a 401(k)'s and The Two Reasons Why You Might Want To

First of all, with most 401(k) plans you are locked into certain investments. These are generally set up so that you win if the stock market goes up. If it goes down, or goes sideways you lose. (There are strategies to protect your position in your pension plans, but it does convert the tax deferred income into taxable income.)

#2 - The main reason that people use 401(k), or any tax deferred vehicle, is that they anticipate that they will pay less tax in the future. Like Robert K says - you can have one of three types of plans - a plan to be poor, a plan to be middle class or a plan to be rich. If you have a plan to be poor, then a tax deferred pension plan makes sense. You will make less money in the future, so it makes sense. But, no one I know personally or professionally has a plan to be poor. My clients all make more money each year then they did the year before. So, paying tax later is a bad idea.

#3 - If you were to invest the money you put in your 401(k) into paper assets, you would have portfolio income. Portfolio income is generally taxed at 15% federal rate (dividends and capital gains). Ordinary income is taxed at 35%. If you invested outside of the pension plan, you would pay 15%. But, if you put money in your pension plan and then pull it out later, you have ordinary income - 35%. So..you are more than doubling your tax by using a 401(k). There is one time that this might make sense...if you have a plan to be poor.

Two reasons that a 401(kl) plan might make sense:

#1 - If your employer is matching a portion of your contribution with additional funds, you'll want to get the extra bonus. Free money! That's generally a good thing.

#2 - If you're young enough, the tax deferral aspect will make up the tax rate difference. That' because you have the time value of money working for you. If you're 25, it might make sense to use a tax deferral plan. If you're 55, it probably does not make sense.

And, just for the record - I LOVE tax free plans such as the ROTH plan. I'll be starting a series on my website (taxloopholes com) on some strategies for making use of the ROTH. Meanwhile, if you have a chance to set up a ROTH - do it! You have to be in the game to take advantage of the strategies.

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Originally posted by BlankenshipFP

5) fund a taxable account with high growth, low income instruments, such as indexes

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