As I learn more about investing, my 401k DOESNT look so great....

[lazyday]

Quote:

Originally Posted by thefed The AVERAGE is about a 1.5% expense ratio.

1. What is the lowest E/R? (for a fund you'd like to invest in, in your 401k)
2. How long do you expect before you retire?
3. How much longer do you expect to work at this company?
4. Do DOG's wrap fees apply?


1. Maybe your plan has an index fund, with "only" about .5% fees?

2. For example, it might make sense to slowly convert 401K to ROTH after retiring, at a very low tax bracket. Another consideration is having some money in each type (taxable,roth,tax deferred) for flexibility.

3. To compare benefit of company 1% matching to # of years of high E/R. If you quit, can roll over 401K to your own account, like at Vanguard.

[cj]

Martha said:

"My gut feeling is to get up to the 401(k) match first, then max out the Roth, and if you have any further ability to save, go back to the 401(k) to max that out."

That seems to be the conventional wisdom from many sources I know and respect.* Don't ever leave matching money on the table!* But then, take advantage of the Roth.* The younger you are, the more this makes sense (to accrue compounding returns in an account that will never be taxed).*

A lot of people do say to max out the 401K first to get the big tax break now, because "when you are older and take money out of your 401K you will be in a lower tax bracket".* I am not at all convinced this is true.* I say, after the 401K match, max out your Roth, and then go from there.* If you can max out both the Roth and the 401K, even better!

CJ

[thefed]

Quote:

Originally Posted by lazyday 1. What is the lowest E/R? (for a fund you'd like to invest in, in your 401k) = 1.4 2. How long do you expect before you retire? 23 YRS,SEMI 3. How much longer do you expect to work at this company?10 YRS? 4. Do DOG's wrap fees apply?NO

[MasterBlaster]

Quote:

I say, after the 401K match, max out your Roth, and then go from there.* If you can max out both the Roth and the 401K, even better!

Along these lines other people think

1) pay into the 401k enough to get all of the match
2) max out the Roth
3) put any extra funds in an after tax, low turnover, low expense ratio index fund.

gains in the after tax account when you take it out will be taxed at (lower) capital gains rates rather than (higher) ordinary income tax rates of a 401K. Between better tax treatment and the low expense ratio of the after tax index fund versus much higher expense ratios and hidden (wrap) fees in the 401K you probably will end up with significantly more real after tax income with this strategy.

[thefed]

Quote:

Originally Posted by MasterBlaster Along these lines other people think 1) pay into the 401k enough to get all of the match 2) max out the Roth 3) put any extra funds in an after tax, low turnover, low expense ratio index fund. gains in the after tax account when you take it out will be taxed at (lower) capital gains rates rather than (higher) ordinary income tax rates of a 401K. Between better tax treatment and the low expense ratio of the after tax index fund versus much higher expense ratios and hidden (wrap) fees in the 401K you probably will end up with significantly more real after tax income with this strategy.

how much are capital gains? 15%?

[MasterBlaster]

Capital gains are at most 15 percent.

If you are in a lower tax bracket then you can either pay 5 percent or nothing (depending on your income level).

[Nords]

Quote:

Originally Posted by MasterBlaster 3) put any extra funds in an after tax, low turnover, low expense ratio index fund. gains in the after tax account when you take it out will be taxed at (lower) capital gains rates rather than (higher) ordinary income tax rates of a 401K. Between better tax treatment and the low expense ratio of the after tax index fund versus much higher expense ratios and hidden (wrap) fees in the 401K you probably will end up with significantly more real after tax income with this strategy.

I agree with #1 & #2.

But here's a more complicated alternative for #3:
What about continuing to invest in the 401(k) (assuming it meets one's diversification & allocation needs) for the annual tax-free compounding. *Then after leaving the company, roll the 401(k) to a conventional IRA. *ERs go through a significant portion of their lives between quitting work and drawing SS, and that low-income period allows lots of room to convert the IRA to a Roth. *Conversion taxes would be at the 10-15% rate and, if the taxes were paid from outside the IRA, would have the additional effect of sheltering even more money in the Roth. *If the conversion was finished before SS eligibility then SS income might not be subject to taxes either.

This scenario has a few assumptions:
- That future tax rates won't be any lower than current tax rates.
- That Roth withdrawals will continue to be tax-free.
- That funds are available from taxable accounts to pay the conversion taxes.
- That the conversion can be done within the 15% bracket or lower, which might take a few years.
- That tax-free compounding beats the 1.5% ER and any other "hidden" costs or fees. *This is the most difficult assumption to make since you'd have to assume that a 401(k) would outperform only if an index taxable mutual fund (with, what, a 0.1% ER?) was paying at least that 1.4% difference in taxes. *That would depend on its annual distributions.

I guess this is why few people contribute past the 401(k) match.

Does your employer offer a self-directed 401(k)?

[MasterBlaster]

Nords:

I may need some enlightenment on your strategy.

If someone is in a 15 percent federal bracket then their capital gains taxes would only be 5 percent. Now compare that to the 10-15 percent ROTH conversion taxes. Considering also the very high expense ratio and wrap fees of the 401K I just don't see the advantage of your strategy.

What am I missing here ?

[Nords]

Quote:

Originally Posted by MasterBlaster Nords: I may need some enlightenment on your strategy. If someone is in a 15 percent federal bracket then their capital gains taxes would only be 5 percent. Now compare that to the 10-15 percent ROTH conversion taxes. Considering the very high expense ratio and wrap fees of the 401K I just don't see the advantage of your strategy.

No, your math is correct for a mutual fund whose only returns consist of unrealized cap gains and doesn't pay a lot of annual distributions.

But not everyone invests in mutual funds like that, and even fewer people bother to look at (1) the impacts of a Roth conversion with taxes paid using funds outside the IRA and (2) the impact of IRA income on their SS taxation. I'm just suggesting that people do the math for their situation.

One issue with your plan is that cap gains taxes might not stay at 5%, although of course Roth distributions might not stay tax-free, either. But the Roth conversion taxes would be paid sooner (and only once) while the cap gains taxes would remain for the rest of one's life. I'm betting it'd be easier for 21st-century Congresses to raise cap gains taxes than it would be to eliminate the Roth tax-free distributions.

[justin]

Quote:

Originally Posted by MasterBlaster Along these lines other people think 1) pay into the 401k enough to get all of the match 2) max out the Roth 3) put any extra funds in an after tax, low turnover, low expense ratio index fund. gains in the after tax account when you take it out will be taxed at (lower) capital gains rates rather than (higher) ordinary income tax rates of a 401K. Between better tax treatment and the low expense ratio of the after tax index fund versus much higher expense ratios and hidden (wrap) fees in the 401K you probably will end up with significantly more real after tax income with this strategy.

The after tax money that you invest is going to be taxed twice - when you earn it and when you withdraw it far in the future. The 401k money only gets taxed once - when you withdraw it. Assuming your future rates will remain the same as the present, you're better off, tax wise, investing in a 401k. Your future tax rates would have to increase in order for the taxable account to be a better option.


(edited to add excel calcs)

[thefed]

Not so sure what a self-directed 401k is. I decide what funds to allocate where, if that's what u mean. But I assume all 401ks are the same.

As far as capital gains, I just got done reading and that make me think even harder. Essentially, if I wasn't working for a year (I retired) and pull out money from a taxable account....long term capital gains would apply.

Given my current #'s, I should have about 450k in an array of investments when I'm 45. The ROTH should be tax-free 15 years after that. The 401k will be taxed at my going rate after 15 more years.(I think my rate will be higher than now, I'm in a low bracket right now).

SO, I think I need 15-20 years of income from something other than the ROTH or 401k...a taxed account. OTHERWISS, what will I draw on at 45 yrs old? The roth or 401k will hit me with penalties of 10% etc.

AGE 45:
SO, assuming I pulled 30k/yr from stocks, and another 15k from part-time work and real estate. That'd put me in the 25% bracket.

How would capital gains work there?

MY GUESS: THE FIRST 7K OF REGULAR INCOME TAXED AT 10%. THE LAST 8K IS TAXED AT 15%. THEN, CAPITAL GAINS IS ONLY 5% UP TO 30K (SO ABOUT THE FIRST 15K OF THE STOCK PROCEEDS). THEN, THE LAST 15 IS TAXED AT 15%.

IS THAT RIGHT? 15K@ 5%, 7K @ 10%. 23K @ 15%

I know this isnt a tax place, but I'm trying to find out what would be most advantageous

My big question is also: what should I be withdrawing from at 45? Roth and 401k's have stiff penalties for taking out earnings early....

[MasterBlaster]

Justin:

That's an interesting little analysis you showed that I will ponder.

However you haven't factored in the much higher 401K expense ratios and wrap fees in your analysis.

Clearly in the original posters situation the low cost, low turnover, after-tax index fund would serve him much better.

[thefed]

JUSTIN: Nice spreadhseet there. Only thing is, 40% seems a bit high for the 401k. Granted, nobody knows, I think 30-35% would be more reasonable, and THAT, would put them about dead even

interesting...

[justin]

Quote:

Originally Posted by MasterBlaster Justin: That's an interesting little analysis you showed that I will ponder. However you haven't factored in the much higher 401K expense ratios and wrap fees in your analysis. Clearly in the original posters situation the low cost, low turnover, after-tax index fund would serve hime much better.

True enough. I changed the analysis to reduce the growth from 8% per annum to 6.5% per annum to reflect an extra 1.5% expense ratio due to crap 401k options. (see spreadsheet below) Clearly, in this particular case, you should go with the after tax investment option.

My original post was meant to show that saving in the 401k was better than saving after tax, investment options being equal. Not the case here (and in many other cases, I presume).

TO DOG51: regarding fidelity as a 401k provider, that is who we have at my workplace. See if you can get them to include their major index funds as your funds you can pick from. We have only 2 index funds at my workplace (total market and extended market - no international index and no bond index). Fidelity has a few great Spartan indexes with 0.10% ERs. Not sure why they aren't in every plan... Oh wait, it's so they can charge you 1.2% ER for a similar mutual fund!

[ats5g]

Fed et. al,

Ed Chang wrote an article, Looking at Expenses of 401K Plans and has a free accompanying spreadsheet - to see just how high of an expense ratio one can tolerate in a 401(k), depending on a number of factors.

- Alec

[justin]

Quote:

Originally Posted by thefed JUSTIN: Nice spreadhseet there. Only thing is, 40% seems a bit high for the 401k. Granted, nobody knows, I think 30-35% would be more reasonable, and THAT, would put them about dead even interesting...

Yes, 30% would make the situations about even. I was attempting to illustrate that higher future tax rates (in this example, 30+%) would put the 401k investment on par with the after tax investment, with respect to taxation.

[thefed]

Quote:

Originally Posted by justin Yes, 30% would make the situations about even. I was attempting to illustrate that higher future tax rates (in this example, 30+%) would put the 401k investment on par with the after tax investment, with respect to taxation.

gotcha. now using the updated 6.5 on 401k returns, can you figure out the break even tax-rate of the 401k vs the taxable account, assumign my current tax rate is 15%. At what tax rate in the future would the earnings match each other.

[justin]

Quote:

Originally Posted by thefed gotcha. now using the updated 6.5 on 401k returns, can you figure out the break even tax-rate of the 401k vs the taxable account, assumign my current tax rate is 15%. At what tax rate in the future would the earnings match each other.

Tehfed,

I will perform financial analysis for you for my normal hourly rate.

My (free) recommendation, if you want to be financially savvy (and wealthy), is to get a copy of microsoft excel and become extremely proficient.

[thefed]

Quote:

Originally Posted by justin Tehfed, I will perform financial analysis for you for my normal hourly rate. My (free) recommendation, if you want to be financially savvy (and wealthy), is to get a copy of microsoft excel and become extremely proficient.

ahhh, what a guy. it'd take ya 5 minutes!

I USED to be ok with Excel, but the newer versions I havent used at all and are confusing. I was ok using EXCEL about 8 years ago, btu not using it has made me rusty.

Thanks for the offer though.

[justin]

Quote:

Originally Posted by thefed ahhh, what a guy. it'd take ya 5 minutes! I USED to be ok with Excel, but the newer versions I havent used at all and are confusing. I was ok using EXCEL about 8 years ago, btu not using it has made me rusty. Thanks for the offer though.

In all sincerity, pick it back up. I'm not sure how I'd get by without excel. Once you're proficient, you can do analysis on pretty much anything quantifiable in minutes. It is a very valuable tool for budgeting, investing, comparing scenarios, etc.