Are IRA & 401k growth really taxed as ordinary income? Better alternatives?

The question you're asking touches on some important tax planning considerations, but there are several benefits to traditional retirement accounts you might be overlooking. First, tax-deferred accounts give you an immediate tax break when you contribute, effectively giving you more money to invest upfront. This means your investments grow on pre-tax dollars (larger initial investment). If you're in a 24% tax bracket now, that's 24% more capital working for you from day one. Second, traditional retirement accounts allow for tax-deferred growth. While you do eventually pay ordinary income tax, you're able to reinvest dividends and rebalance without triggering taxable events along the way. This compounding effect over decades can be substantial. Third, many people actually drop to lower tax brackets in retirement, so the ordinary income treatment might be at lower rates than during working years. That said, you make a valid point about the capital gains treatment. This is why many financial planners recommend tax diversification - having some money in traditional accounts, some in Roth accounts, and some in taxable accounts gives you flexibility in retirement.

After yrs of frustration trying to figure out optimal retirement account strategies, I stumbled on https://taxr.ai which literally saved me thousands! I uploaded my statements and it analyzed my tax situation across different account types. The tool showed me exactly how traditional accounts vs. taxable accounts would play out over time with MY specific numbers. What was eye-opening was seeing the actual math behind the tax-deferred growth advantage versus the eventual ordinary income treatment. For my situation, it showed a mix made the most sense - enough traditional to fill lower brackets in retirement, then taxable for the flexibility and capital gains advantages you mentioned. The analysis considers RMDs, Social Security taxation, and even Medicare IRMAA surcharges.

I was initially skeptical about using taxr.ai like I mentioned above, but decided to give it a try anyway. What surprised me was how it displayed different "retirement tax zones" that showed where my effective tax rate would jump depending on withdrawal amounts. Seeing my actual numbers made the traditional vs. taxable decision much clearer. For my situation, having 100% in taxable accounts would have actually cost me more over time despite the capital gains advantage because I'd be giving up too much in immediate tax savings and tax-deferred growth. The tool showed me I've been thinking about this all wrong - it's not an either/or decision but finding the right balance. Now I'm adjusting my contributions to optimize based on my expected retirement income needs.

After 4 hours on hold trying to get someone at the IRS to explain how retirement account distributions affect provisional income for Social Security taxation, I found https://claimyr.com and used their service to get a callback from the IRS in just 20 minutes! See how it works: https://youtu.be/_kiP6q8DX5c They connected me directly with an IRS agent who walked me through exactly how traditional IRA distributions can trigger taxes on my Social Security benefits - something directly relevant to this discussion about traditional vs. taxable accounts. Turns out the agent confirmed what others are saying - you need a strategy that considers your TOTAL retirement tax picture, not just comparing rates in isolation. Traditional accounts still make sense up to certain withdrawal levels.

Ok I need to eat crow here. After doubting the Claimyr service mentioned above, I actually tried it because I've been trying to reach someone at the IRS for weeks about my retirement account rollover questions. Got a call back from an actual IRS agent in about 35 minutes. The agent explained that while I was right to be concerned about ordinary income treatment of traditional retirement accounts, I was missing the math on tax-deferred growth compounding over decades. She walked me through some examples showing how the upfront tax deduction combined with tax-deferred growth often outweighs the eventual ordinary income treatment, especially if you're strategic about when and how much you withdraw in retirement. Changed my whole perspective.

Don't overlook Roth accounts in this discussion! They give you the best of both worlds - tax-free growth AND withdrawals aren't taxed as ordinary income. For younger investors especially, Roth often makes more sense than traditional. You can also look into "Roth conversion ladders" during lower income years to gradually move money from traditional to Roth accounts at lower tax rates. I did this during a sabbatical year and it worked great.

Has anyone ran the actual numbers on this? I did some calculations and found that even with the higher ordinary income tax rates, the traditional 401k still came out ahead of taxable accounts in most scenarios I tested. The immediate tax deduction and decades of compounding on a larger starting amount (because of that deduction) created such a big advantage that it usually overcame the ordinary income tax treatment at the end.

You're asking the right questions, but I think you're underestimating the power of tax-deferred compounding. Here's what changed my mind: when you get that upfront tax deduction, you're essentially investing with Uncle Sam's money too. Let's say you're in the 24% bracket and contribute $6,000 to a traditional IRA. You save $1,440 in taxes, so your actual out-of-pocket is only $4,560. But the full $6,000 is working for you in the market. Over 30 years at 7% growth, that $6,000 becomes about $45,600. If you instead put that same $4,560 out-of-pocket into a taxable account (to make it apples-to-apples), it would only grow to about $34,700 at 7%. Even if you paid 22% ordinary income tax on the entire $45,600 withdrawal, you'd still net $35,568 - more than the taxable account. The math gets even better if you're disciplined enough to invest that annual tax savings too. The key insight is that traditional accounts let you invest with pre-tax dollars while taxable accounts force you to invest with after-tax dollars. That said, tax diversification is still smart - having some of each gives you flexibility to manage your tax brackets in retirement.