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Chapter 6. Saving Pre-Tax or After-Tax—D... > Better the Tax Devil You Know Than t... - Pg. 69

Saving Pre-Tax or After-Tax--Does It Really Matter? 69 Better the Tax Devil You Know Than the One You Don't "Hey, I know what tax rates are today. It's a sure bet they'll be higher when I retire. So why shouldn't I pay tax today?" On the surface it would seem to make sense to pay taxes on your income now, if you think that tax rates will be higher in the future. This might make sense except for four facts of finance: · Money is always better in your pocket than the IRS's. Once you give it to them, you don't get it back. · Money you give to the IRS today doesn't generate any income for you over the years. · Tax rates have gone down. Prior to 1986 we had 15 income tax rates, the top one being 50 percent. In 1997, tax rates ranged from 15 percent to was 39.6 percent. And by 2006 tax rates will top off at 35 percent. · Except in very rare cases, you are better off taking the money you didn't pay in taxes and in- vesting it for your benefit. (See Figure 6.1, earlier in this chapter.) Figure 6.1. Now, there is a potential case to be made given the new super long-term capital gain tax rates that went into 2001. These new rates are as follows: If Your Income Tax Bracket Is 15 Percent Sell investment after 12 months Sell investment after 5 years If Your Income Tax Bracket Is 28 Percent or Higher Now Sell investment after 12 months Sell investment after 5 years * * Five-year Tax Rate 10 percent 8 percent 20 percent 18 percent holding period cannot begin before 1/1/2001 Let's say you're a pessimist and you decide not to use a 401(k) to save for retirement. You're betting that tax rates will be higher when you retire than they are now, and you hope to take advantage of the new capitalgain rates. You figure, better to pay a 20 percent tax now than a 28 percent or more tax later on.