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Contribute 401k vs taxable accounts. And roth vs traditional
Old 02-25-2013, 06:17 PM   #1
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Contribute 401k vs taxable accounts. And roth vs traditional

My wife currently has a roth 401k that we contribute 6% to get the company match. We are looking to put more money into her retirement but I can't decide if we should max out her 401k due to the 1% of expenses it charges. Would it make more sense to invest in non-tax sheltered accounts with lower expense ratios? Also, should we be investing in a roth or traditional 401k? Currently in the 28% tax bracket and doubtful we will ever be higher, if anything we will be lower when she starts working part time after we have kids. Currently we both max our Roth IRA's and I have a pension. THANKS
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Old 02-25-2013, 07:16 PM   #2
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If you expect your marginal tax rate to be lower in retirement then you would be best off with tax-deferred savings (traditional 401k) rather than the Roth.
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Old 02-25-2013, 07:23 PM   #3
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You should use the traditional 401(k), get the tax deduction, and contribute even more than 6%. A 1% fee in a 401(k) is not so bad, since some plans have fees above 2%. The tax-deferral and company match trump that fee easily. Indeed, I would contribute the max possible to the 401(k), then contribute more to a Roth IRA. If you have money in taxable accounts, I would live off that money, so that the trad 401(k)s and Roths could be maxed out.
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Old 02-25-2013, 07:26 PM   #4
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If you expect your marginal tax rate to be lower in retirement then you would be best off with tax-deferred savings (traditional 401k) rather than the Roth.
+1

Keep contributing to get the company match. If, like most early retirees, your marginal tax rate will drop in retirement, then contributing to a roth 401k isn't tax efficient for you -- especially if it comes with very high fees. A traditional 401k would likely suit your needs better.

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Old 02-25-2013, 07:49 PM   #5
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Ok so i'm new to all this retirement stuff. So we already max out our Roth iras every year. She had the option for a Roth or traditional 401k so I have no clue what to do. I don't know how to estimate what bracket we will be in when we retire. I know I will have at least one million and possible up to four million coming from my parents. So I assume what I made on those investments yearly would put me in a higher bracket? I will also have a pension in retirement.

All that says, should I max out her 401k this year over buying into non tax sheltered funds or stocks with cheaper expenses ratios
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Old 02-25-2013, 08:00 PM   #6
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If you are going to save the money for retirement anyway, then it might as well be in a tax advantaged account as not. You only get so much tax advantaged space each year and lose whatever you don't use.

Whether Roth or Trad is better depends on many factors you'll have to assess for yourself. Also for many early retirees, there's the possibility of some years where income is low before pension and distributions kick in that can be used to convert Trad to Roth at low effective tax rates. If you will be at higher earning rates (meaning higher tax rates) later, then Roth is the way to go. For me, I'm earning more at the end of my career than I expect in the future, so Trad makes more sense.
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Old 02-25-2013, 08:07 PM   #7
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Ok so max out the 401k is the consensus. Are there any good calculators or articles to help work out what bracket I could expect to be in when I retire. That is such a hard thing to figure out for me
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Old 02-25-2013, 08:12 PM   #8
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What about doing fifty fifty in each?
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Old 02-25-2013, 08:19 PM   #9
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No, do 100% traditional 401(k) and the Roth IRAs. There really is no doubt about this.

One can have a multimillion dollar portfolio and pay no taxes if they work it right. There is no way to figure out taxes in the future.

One can assume though that due to inflation, that a million dollars won't be what it used to be. I think I can safely predict that someone withdrawing $250,000 a year in the future will still be in the 15% tax bracket or lower because a Big Mac will cost $1,000 or something like that.

But start out this way and in 20 years change it if needed when you have more clarity. So far for me, I haven't had to change it.
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Old 02-25-2013, 08:51 PM   #10
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Ok so max out the 401k is the consensus. Are there any good calculators or articles to help work out what bracket I could expect to be in when I retire. That is such a hard thing to figure out for me
The best calculator I have seen is Esplanner. It's not free, but it covers the most. It will calculate your federal and state taxes each from now until your estimated date of death. It will also calculate SS payouts, RMDs, and much, much more.

You should max out your 401k as others have suggested. The 1% management fee in the funds is not the most important consideration. Most Americans will only stay in their current job for 5 years. Therefore the average American will only pay excessive 401k fees or have to cope with limited investment options for a few years after which (once separated from the company) he will roll it into an IRA to live for decades.

Tax-deferred accounts, including 401Ks, have benefits beyond the company match even if your marginal tax rate is not lower in retirement, although it will be for most people. The right way to think of a 401k is that you could make the contribution now and pay the tax immediately. Or you could contribute to the 401k both your own ultimate money plus the taxes that you will eventually pay to the govt. In exchange for agreeing to manage the govt's money your own money will grow forever tax-free. If your tax rate in retirement is the same as while working (not very likely, but possible) you will end up paying the govt its original tax plus the gains and income your management has achieved for that money. You will get to keep your own contribution and all it has earned forever.

Here's an example:

current bracket: 25%
401k contribution: $8,000
portion of contribution that belongs to govt: $2,000

you invest and at retirement that $8,000 has grown to $16,000
retirement tax bracket: 25%
you draw out all of the money:
tax due: $4,000
portion that is not taxed: $12,000

Of course, if your tax rate is lower, you would do even better since you would get to keep some of the govt's gains. Plus you might have moved out of an income tax state into a no-income tax state or abroad. In that case you would never pay the state anything.


How much of a benefit that is depends on how long the 401k lives including its life as an IRA after your separation from the company and possibly as a Roth IRA. The tax-deferred money might live as long as you, but it could live as long as your wife or your children.

The reason you should contribute to the 401k now despite the temporary disadvantages, is that the 401k lets you contribute a lot more per year than an IRA or any other vehicle, unless you are self-employed.

For those who can afford to save for retirement, the 401k is by far the best deal available now.
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Old 02-26-2013, 04:51 AM   #11
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don't forget folks tax rates can rise but the brackets have been allowing more and more income through each year at lower and lower tax rates.it has been this way for 40 years.

marginal rates can go up and you still may pay less tax down the road.

another few years and 100k will be in the 25% bracket with most of it going through at lower rates.

it is not just a case of whether you think taxes will be higher or lower ,it is about the amount of income going through at lower rates too .

that makes the choice of which vehicle to use even tougher.
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Old 02-27-2013, 11:04 AM   #12
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don't forget folks tax rates can rise but the brackets have been allowing more and more income through each year at lower and lower tax rates.it has been this way for 40 years.

marginal rates can go up and you still may pay less tax down the road.

another few years and 100k will be in the 25% bracket with most of it going through at lower rates.

it is not just a case of whether you think taxes will be higher or lower ,it is about the amount of income going through at lower rates too .

that makes the choice of which vehicle to use even tougher.
The tax bracket levels inflated from last year to this year at a rate of ~2.57%. Using this for the future rate of inflation, my projections show the bottom end of the 25% bracket exceeding $100,000 in 2026.

The average tax bracket inflation rate since 1913 has been 3.33% so the $100k start of the 25% rate may come sooner.
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Old 03-01-2013, 04:22 AM   #13
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many folks forget the aspect of it is not so much what marginal rate you are at as it is what is happening to the brackets below.

new york and new jersey have very close state tax marginal rates but what a difference in amounts paid becuse nj allows so much more through at lower tax rates.
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Old 03-01-2013, 10:52 AM   #14
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What about doing fifty fifty in each?
I don't know if you need to follow the consensus, because it seems to be all over the map. Just using some logic will suffice.

We know it is a given we can't know future tax rates or the size of your IRA fund and the amount of funds you will be FORCED to withdraw from the IRA from RMD's.

The fact that I do know (barring any serious changes to the Roth / non-Roth tax treatment) is that if at retirement you have roughly 50/50 Roth and non-Roth funds you will be most likely able to control your tax rate from 0 (or almost zero) up to whatever you feel is reasonable. As I have outlined on a few other posts.

So, I think that should be your goal -- remembering to include the fact that the company match will be non-Roth (no matter what) so you may need to do slightly more Roth.

fd
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Old 03-01-2013, 10:59 AM   #15
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Good advice thanks. By the way, the company is contributing the match to the Roth not traditional 401K. Are they not supposed to do that
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Old 03-01-2013, 11:36 AM   #16
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the first priority is to get the company match. everything else is less important.
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Old 03-01-2013, 11:50 AM   #17
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Probably already said but the traditional 401k takes money off the table that would have been taxed at your highest rate. If you have a higher income and are truly on board with LBYM, you'll see a huge benefit from the traditional 401k, and you can manage your withdrawals in retirement to minimize the tax burden then.
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Old 03-01-2013, 01:49 PM   #18
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Probably already said but the traditional 401k takes money off the table that would have been taxed at your highest rate. If you have a higher income and are truly on board with LBYM, you'll see a huge benefit from the traditional 401k, and you can manage your withdrawals in retirement to minimize the tax burden then.
It will be very HARD to manage those withdrawals -- and in fact the IRA mandates via the RMD's what you MUST withdraw -- unless you have some non-taxable income (such as a Roth) to use as your alternative income source.

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Old 03-01-2013, 01:53 PM   #19
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Good advice thanks. By the way, the company is contributing the match to the Roth not traditional 401K. Are they not supposed to do that
NO, they cannot --- but you may just not be aware of where the money is going-- in some cases the company match money just shows up in the account as "company match" and not as being in a specific account.

Just because you contribute money to the Roth and they match it, does not mean they are matching it in the Roth.

fd
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Old 03-01-2013, 02:24 PM   #20
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It will be very HARD to manage those withdrawals -- and in fact the IRA mandates via the RMD's what you MUST withdraw -- unless you have some non-taxable income (such as a Roth) to use as your alternative income source.

fd
RMD's kick in at 70.5, not exactly early retirement....? Obviously the 4% rule most adhere to here is the dominate influence on what people pull, but in any case I'll be pulling much less than our household income now when I retire.
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