Does Your 401k Contribution Actually Benefit You?

This week I was listening to a recent Money with Katie Episode (Link). During that episode they talk about lifetime tax drag and how saving in different vehicles could change your lifetime tax burden. It got me wondering about a few different things about lifetime tax burden. I thought we’d discuss these here.


I am not a tax expert. There are problems with the models that I present today. This should solely be taken as opinion. Consult your financial advisor before making any changes to your investment strategies.


As always, let’s start with the assumptions I’m making at the start.

Individual assumptions:

Contribution = $12,000/yr

Net worth (year 1) = 0.

Years at which Withdrawals start= 40.

Years of withdrawal = 20.

Spend = Income-taxes-contribution (this number is different between 401k and taxable cases. I’m assuming no tax benefit is saved).

Tax assumptions:

Tax brackets = 2024 brackets (taken from Nerdwallet).

Dividend taxes = 0.5% of net worth in year i-1. This also changes depending on the model and starts at 0%.

Standard deduction = $14600.

state tax = 0%.

401k withdrawal tax brackets = taxable income brackets.

Investment assumptions:

Investment returns = 4%/yr.

Dividend yield = 2%/yr. These two variables could probably be mixed into one and the actual numbers don’t matter too much.

Funds are essentially identical across both accounts.

Other assumptions:

Spending in retirement = spending before retirement. I do not include the taxes from the withdrawals. That is part of the spending.

inflation =0.

Tax brackets do not change.

Tax in year 1 (or 40 for withdrawals)= taxes across all years.

How Much Does Your 401k Save you?

With all of that out of the way let’s briefly discuss the first set. For this I wanted to just see how much your 401k contributions save you on your lifetime taxes. Let’s talk about the specifics that differ from above:

Dividend tax =0%

Income ranges from $40,000/yr to $200,000/yr

So running some simulations on that I get the following %difference in lifetime taxes between the two situations. For $40,000/yr it was 90.55%. For $200,000 it was 3.77%. The graph below shows the changes in % saved on lifetime taxes based on income.

I’m thinking what keeps the decay from looking smooth is the differences in spending between the two groups during retirement. I’m also surprised it doesn’t look more exponential and is instead rather linear. I’d assume that the decay would be more curved as you’re cutting x amount of money at y tax rate and the higher your income is, the higher likelihood that is at a higher tax rate.

But the long short of it is that the less your make, the bigger an impact a 401k contribution seems to make. I’m not sure this really is much of a surprise for anyone.

What About Other Forms of Resistance?

In the first example we had nothing to model dividend taxes. My model was getting rather bulky so I’ve just added on a simple % of portfolio removed as noted above. We’ll run the same example with a 0.5% dividend tax to include that as well. This is simply calculated as .05%*Net Worth(i-1). It’s definitely simplified in some ways, you could do some form of graduated scale to account for the contributions throughout the year.

Running essentially the same simulation as above with this tax you get the following graph.

As you can see, adding some form of dividend tax smooths the curves out and actually makes it much more linear.

Also, interestingly at the lower ends the taxable portfolio eventually catches up to the 401k. See the graph below. It was just an interesting graph that I found. I’m guessing this is due to the lower spending in the taxable case. I just thought it was interesting.

Does changing your contribution amount change this?

So I ran the same simulation as the dividend case again, but this time the contribution limit changed from $1000 to $24,000 each year. For this case I kept income constant at $200,000. I was just curious if it made a huge difference. See the graph below.

As can be seen, it trails fairly linearly up and to the right. While it does help, moving the ball roughly from 9% at the lowest end to 12%, it wasn’t as huge of a change as I thought it would be. I’m less surprised at how linear this is, as the tax rate is effectively constant except for the effect of changing contribution limits.

What else is there

Now there are some other situations that could be looked at that were beyond the scope of this post. Perhaps you consider Roth accounts. Maybe you keep spending constant between the two accounts and everything extra goes into a taxable account. These are situations that I looked at programming but the more I worked towards these the more difficult the program that I had been writing got. I also could get better with the dividend tax and actually calculate what the tax value from each year’s dividend yield would be. You could add something for the taxes paid to keep spending the same as well. There could be plenty of changes that could work with.

Two really interesting cases that I didn’t want to mess with at this point in time was a changing income tax over time. If you work in a low income tax state and retire to a high one or vice versa could be an interesting calculation and how the withdrawals at those times could change that percent difference calculation. The other would be changes in the tax brackets down the road. What if income tax rates double after inflation by the time retirement hits or if capital gains taxes increase while income taxes remain the same. Some of these other tax changes could make for interesting follow ups to this post. Maybe I’ll work on that down the road just to see what the numbers would look like I’ve yet to be able to predict what the future of tax legislation is.

Wrapping it Up

So there you have it, how much your 401k contributions actually help lower your lifetime tax bill across a variety of different situations from how much income affects it, dividend taxes affect it, and finally how much your contribution and income changes your lifetime tax burden. There were plenty of things that I did not consider for this model, but I think from a very simple layer it does cover that. I also think unless you’re at the extremely high end of the income spectrum, it is a massive win to contribute all that you can to your 401k, and even then it probably still makes a lot of sense. My advice is to continue maxing out your 401k under most situations.

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