Consider the situation where a person who is still in their working years inherits cash, lets's say $100,000.
A. It could be invested in mutual funds. When withdrawn in retirement, the principal is not taxed and the gains are taxed as LTCG at 15%. (And there may be some dividends taxed at 22% along the way.)
B. The person could increase their pre-tax 401k contributions from (let's say) $10,000 per year to the max of $31,000 per year. This results in a $15,000 reduction in take-home pay, which is made up from the cash inheritance. So the 401k can be maxed out for about 6-1/2 years. This results in an immediate tax savings from the wage income of at least $5000. But it converts the inheritance, which was tax-free, into an instrument that could be taxed at 22%.
C. The person uses strategy B but places the money in a Roth account in the 401K. The person gets no immediate tax savings, which means the strategy only works for 5 years instead of 6-1/2. But the gains after retirement are now tax-free instead of being taxed at 15% or 22%.
Looks like Roth is the way to go. Or am I missing something?
(Person already has a Roth IRA that is maxed out, and already has a Roth 401k, so the 5 year clocks are already satisfied.)
