This. Besides the fact that the money goes in tax-free, one of the biggest bonuses is that the money grows tax-free. In the beginning that's not a big deal, but when your 401(k) balance is in the six-figure range it is a very big deal. Cumulatively, you can save tens of thousands this way over a decade or two.

There is no extra growth because it's tax free. The only difference is the tax rate now vs the tax rate then. If the tax rates are the same, then the amount is the same.

Contribute $18K/year pre-tax with 7% growth per year is $248,696 after 10 years. Take off 15% in taxes and you're at $211,392

$18K/year taxed at 15% is $15,300, contribute $15,300 per year post-tax with 7% growth per year and viola, $211,392

Sure there's some tax nuances, but the math doesn't care when the tax amount is applied. (This assumes a 15% tax bracket or lower for one, as then capital gains are not taxed)

**Eric** - what about dividends? Either I really have a hole in my understanding or you pay taxes on all dividends in normal investment accounts but not in a 401(k). So if you have a 401(k) with $250k that earns $6,000 in dividends per year, you will pay $0 in taxes each year. That same amount in a normal investment account would result in an extra $900 in taxes (assuming 15% if you are in the 25% tax bracket. If you are in a lower income bracket it might very well be $0 and this is all mute).

Cumulatively after a decade or so the non tax-deferred investment account may rack up ~$10k in taxes (assume some growth) while the 401(k) would rack up exactly $0. Correct?

That's correct, but all withdrawals from the 401k are taxed at ordinary rates. In Eric's example, that would be 15%, same as the dividend tax rate you used. So it's a wash still if the tax rate stays at a flat 15%. It will never do that, but his statement is still fact. The timing of the tax is irrelevant, only the rate matters in the analysis.

Nereo's point is that if you pay a tax on dividends or capital gains, then it is a big deal, even if the starting and ending tax rates are the same. If you have the tax at an intermediate stage, you don't benefit from that growth. I think you understand this, but for anyone else following along, here's a simplified example:

In a 401k:

Start with a $10,000 balance. Receive a dividend of $300. Reinvest the dividend. Market goes up another 10%. You're left with (10000+300)*1.1 = 11,330.

After 25% taxes you have .75 * 11330 = 8497.50

In a taxable account:

Start with an $7,500 (in this example the investor is in the 25% tax bracket). Receive a dividend of $225, pay taxes of .15*225 = 33.75. Reinvest the 225 - 33.75 = 191.25. The market goes up another 10%, giving you a balance of (7500 + 191.25) * 1.10 = 8460.37. Owe capital gains tax of .15*(8460.37-7691.25) = 115.37. Final balance is 8460.37 - 115.37 = 8345.

With more years and more intermediate steps the effect gets bigger.

Won't the payment of dividends reduce the value of your investment proportionally? So in the first case with $10,000 and a $300 dividend you are left with $9,700 investment and $300 dividend reinvested so $10,000. Market goes up 10% so you have $11,000 and have to pay tax on all of it. Withdraw and pay 25% income tax = $8,250

In the second scenario you have $7,500 in a taxable account, get $225 of dividends, and owe 15% of that in taxes (so reinvest 85% of dividend payment back into it) and end up with $7,466.25. 10% market increase yields $8,212.88. 10% capital gains owed on ($8,212.88 - ($7,500 + 0.85*225) = $521.63), which is $52.16. So total ending value of $8,160.72.

So I get slightly different numbers, but agree with your point. The money in the 401k account won't be subject to dividend/capital gains taxes, and that difference will be able to continue to compound in the account.

However if you lower the tax bracket from 25% to 15%, and the dividends/capital gains from 15% to 0% and you end up with the same value in both scenarios.

The real benefit as I see it though is being able to take that chunk of money that is in the 15% or 25% bracket and avoid taxes completely on the front end, allow those tax savings to grow and compound with your investment, and then withdraw it at a lower (or even 0%) tax bracket on the back end thus avoiding taxes altogether.

As for the ops original question, it would depend on your personal situation and where you expect to be when you start to withdraw that money. I'm not sure if I understand correctly, but it sounds like the op might have a misconception of how tax brackets are applied and taxes are calculated. If I contribute just enough money to lower me into the 15% bracket, that means I am still paying 15% on that entire bracket. Every dollar I am able to shelter still saves me 15 cents of taxes (until I hit the 10% bracket). Unless you plan to increase your spending significantly once your retire you are almost certainly better off contributing more to a 401k/ira even if it doesn't bump you to another tax bracket. You still benefit from that reduction in taxes.