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Contribute to 401k while taking FEIE?
Old 12-20-2010, 01:20 AM   #1
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Contribute to 401k while taking FEIE?

Hello Everyone,

First post here. Like most of you I'm a prodigious saver and hope to retire early. I'm living overseas and trying to determine if I should contribute to 401k or just a taxable investment account. My resident country has very low taxes, and my decision to contribute to a 401k or taxable account will not affect taxes for that country. I will eventually move back to the US, possibly as soon as 1 year from now.

My company matches 50% up to a maximum of 6% contribution. My salary is under the Foreign Earned Income Exclusion (FEIE) amount, so that I owe no US taxes. Therefore, any money I would put into the 401k would not be taxed going in. I don't have access to a Roth 401k and cannot contribute to Roth IRA (no earned income). Any dividends and capital gains up to US$9350 in taxable accounts would not be taxed (standard deduction + personal exemption).

The only benefit I see to using the 401k is the match, as well as continuous tax-free compounding. I have 33 years to go before the 401k opens up at 59 1/2. My 401k charges high fees, however there is a high possibility of rolling over into a traditional IRA at some point, or making Roth IRA conversions. Because I save so much (70% of my gross), about 30% of my investments are in taxable accounts, and the remaining tax deferred.

Should I contribute up to full company match (6%), or should I max it out? Somewhere in the middle? Any feedback would be greatly appreciated
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Old 12-20-2010, 06:01 AM   #2
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I would max it out unless you have major outstanding debt or large anticipated expense with your upcoming relocation/return. My main reason as you stated: "continuous tax-free compounding".

Good luck.
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Old 12-20-2010, 08:24 AM   #3
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Do you at least get to withdraw your contributions untaxed? I can't see that it makes any sense to contribute except for the match otherwise. No need to have post-tax contributions taxed again on the way out. Try a simple spreadsheet calc to see if any 401k option makes sense.
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Old 12-20-2010, 08:53 AM   #4
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With rollover provisions, a Roth is possible in the future, say during a low income year with low taxes, or a high income year when there is extra income to pay taxes and fund a Roth rollover. You have a long time horizon. The future path to Roth could save you a bundle IMO. I would max the 401K out if I were you or very minimum contribute to earn the company's match.
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Old 12-20-2010, 09:28 AM   #5
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Quote:
Originally Posted by Animorph View Post
Do you at least get to withdraw your contributions untaxed? I can't see that it makes any sense to contribute except for the match otherwise. No need to have post-tax contributions taxed again on the way out. Try a simple spreadsheet calc to see if any 401k option makes sense.
No, unfortunately it is not taxed on the way in but taxed on the way out. Say I invest in bonds this year, which compounds for 33 years assuming 25% tax bracket:

401k:
(16500*1.03^33)*.75 = 32822.64

Taxable:
16500*(1+.75*.03)^33 = 34385.34

With higher returns on dividends (i.e. 4+%) the 401k eventually makes more sense. However there are tax exempt bond funds currently yielding over 3%. Other investments may be more tax efficient. Assuming I did the rough math correctly, it looks like taxable would be a clear winner this year.

I am not familiar with conversions to Roth IRA. What is the limit each year? If there's no limit, about how much is practical to convert each year? I would assume that a few years without maxing the 401k would not make too much difference, so right now I'm leaning to just contributing 6% to 401k.
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Old 12-20-2010, 12:04 PM   #6
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You have probably made an error in your tax calculations. The reason is that some of the money your earn or withdraw is taxed at 0%, some at 10%, some at 15%, etc.

If you read some of the other threads and learn about taxes, you will see that folks like TromboneAl got the full deduction for contributing to their 401(k)/IRA, but in the withdrawal stage, they are pay 0% in taxes.

Thus contributing to the 401(k) is paying ZERO taxes on the money now and possibly ZERO taxes on the money in withdrawal. In any event, you need some tax-deferred accounts in order to have the annual bond dividends (ordinary income) not taxed each year (i.e. tax-deferred) until much later. This is such a standard concept, that if you don't get this right now, you are probably screwed for life.
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Old 12-21-2010, 12:42 PM   #7
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Roth 401k vs 401k have the same limits. ie: if you can invest a max of $15000, you can do so at 100/0% or 0/100% or anything in between such that (100-amt/amt)% if you are math oriented. or more simply Roth 401k added to 401k cannot exceed your max of $15000. Your top limit may differ than $15000, but you should get the idea. The advantage, if you can afford it, is that putting in Roth 401k will tax you up front and future returns are tax free. At a 25% tax bracket, you are tax advantaging an additional 25%. plus if a personal crisis hits, you can access your invested money.

The big advantage of putting in the maximum early is to harness compound interest to your best benefit. If you max your investment for 9 years and then quit any additional investing, you will still be ahead compared to someone who skips those first years, but maxes for the rest of his life. Early saving is much tougher, you are starting with everything, but that is also what changes FIR to FIRE.
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