That's an interesting approach, but I don't know if every company's 401(k) is set up to handle it. For example, I know the federal Thrift Savings Plan stops payroll deductions right at the $16,500 mark for participants younger than age 50.
I guess investors would also have to consider the benefit of the tax-deferred compounding against the issue of many 401(k)'s high expense ratios. (Not an issue with the TSP.) Hence the conventional wisdom to only invest in a 401(k) to the match, then max out the conventional/Roth IRAs.
I’m sure not every company will allow this – but there are no federal rules preventing it. If you have extra money available to make in long term investments, it’s at least worth a phone call – or a read through the 401K plan materials to see if this strategy will work. You need the plan to allow the following
1. You can make after-tax (traditional) contributions.
2. You can take out after-tax contributions for any reason (that is, you don’t need a hardship). There may be a small administrative fee for preparing the paperwork and cutting the check every time you do this (for me it is on the order of $10-$20).
Item 2 above takes care of the issue of having bad options in your 401K plan since you can roll the money out of the 401K and put it into your own personal IRA that’s invested into what ever you want. FYI – I rolled money out of my 401K directly into my IRA three times in 2010.
If you really don’t like you’re 401K options to even leave money in there for a few months – there is usually some type of cash option where you can just let it accumulate for a while before you roll it out.
Also – if you really don’t like you’re 401K options, some plans (like mine) allow you to take out the company match any time you want after you’re vested. For several years (actually since the day I became vested in the company match), I’ve been at least annually taking out the company match and rolling it to a Traditional IRA (last year I rolled it to directly to a Roth IRA and will pay the taxes on the conversion).
As an example, my companies plan allows me to contribute up to 30% of my pay into the 401K. In 2010, I put in 5% of my pay as pre-tax contributions and 25% of my pay as after-tax traditional contributions. Note that I’m under 50 and 30% of my pay is over the $16,500 limit for pre-tax contributions. In 2010, my company matched 50% of what we put in up to 8% of our salary. It doesn’t matter what type of contributions you make – I received the full match. I rolled out every thing I could (pre-tax contributions + their growth and company match) directly to a Roth IRA. When I rolled the money out of the 401K, the plan told me how much of it was pre-tax. Since I rolled the money into a qualified plan, I won’t owe any penalty. Since I already paid taxes on the “pre-tax” amount, I won’t owe any tax on these funds. I will owe normal income tax on everything else that was converted (the growth of the pre-tax at the time I converted and the company match).
I also contributed $5K directly to a Roth IRA.
To give some real numbers to this technique to show how useful it can be, let’s say you make $100K/year and you’re company allows you to contribute 30% of you’re pay to a 401K. Let’s say you max out the 30% all with after-tax $. At the end of the year you convert it all to a Roth IRA. The amount rolled will be $30K +/- any growth or loss the investment had during the year. The only tax owed would be on the growth.
Let’s say you are also married and you’re annual income allows you contribute to Roth IRAs. You can also put in $10K ($5K for each spouse) directly into Roth IRAs.
In this example, the couple was able to essentially contribute $40K into Roth IRAs.
If you’ve got the money to do it – defiantly worth checking out to see if you can.
