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In a Feb. 13 column on Roth 401(k)s, I pointed out that the tax savings generated by the conventional 401(k) -- if invested -- would make up for any advantage of creating tax-free Roth 401(k) proceeds by paying taxes today on the contributions to a Roth.

The key to making a successful long-term decision lies with understanding all there is to know about investing in mutual funds and avoiding taxes on their annual investment success. This is important to know regardless of whether the after-tax account is a result of tax savings factored into a Roth comparison or any non-retirement plan money we might have saved and/or generated from real estate sales, gifts, inheritances, or even successful transactions on eBay.

Most financial industry Web sites, by now, have added so-called "Roth analyzers," tools designed to help investors come to the same conclusion if they fill in the right tax arithmetic.

Overwhelmed by curiosity, I used one of the online calculators and experimented with the assumptions to see what numbers would come up.

I compared the Roth vs. a traditional 401(k) for the next 10 years and considered a $20,000 contribution because I'm over 50.

First of all, I liked that the traditional 401(k), along with its tax-saving side-fund component, added up to $462,000 ($310,000 for the 401(k), another $152,000 for the side fund) vs. the Roth at just $310,000.

The Roth had no tax-savings side fund because the cost of an after-tax Roth contribution meant paying taxes today that could have otherwise been deposited into the side-fund described above.

Now the question is, how do we earn money in mutual funds and avoid having to pay taxes on it until we take it out?

We all know by now that owning a mutual fund invested in stocks generates tax liabilities out of thin air. We own the fund and haven't touched it, but the shoebox we hand our tax guy includes a 1099 form claiming that we had some taxable gains that came as a complete surprise. "Why me?" we ask.

Index funds and tax-managed funds solve this problem. These funds, by design and operation, generate little in the way of taxable gains. Years later, when you start nibbling away at them to support that eccentric personal lifestyle in retirement, you sell portions of the fund and pay a capital gains tax based upon the difference between the sales price and your original purchase price.

Index funds accomplish this delay in tax liabilities by having very little turnover or sales of the stocks in the portfolio.

The famous S&P 500 index funds typically sell only about 5 percent of their portfolios in a year. Compare this to the more average fund's 50 percent turnover that generates annual tax liabilities.

Tax-managed funds are those that regularly sell some losers whenever they need to offset some successful, profitable trades. These funds operate from year to year generating only modest amounts of taxable income.

When the time comes to take money out of these funds to pay for retirement expenses, sell the funds piecemeal and pay capital gains on just what is sold. Capital gains taxes, hopefully, will generally be less than the tax on regular income. The combined effect of having tax-deferred build-up and then a capital gains tax on what comes out as income creates a very positive number for the traditional 401(k) side-fund.

For the side fund, it is safe to assume a 10 percent return (stock market averages going back many years) and a 25 percent tax rate on the distributions. (Combined capital gains state and federal.)

Using these assumptions, the traditional wins hands down based on simple arithmetic, and it offers the added benefit of 50 percent more money at any given time.

One of the greatest pleasures later in retirement comes from going online, punching in a password, and just looking at your account balance. Avoiding unnecessary taxes along the way will make that experience all the more enjoyable.

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