New Job and 401K Question

[Pleeplus]

Hi all – I am new to this investing stuff and have a question. ​

My wife has recently transitioned to a new job and now has the opportunity to start investing in their 401K plan. The company does not match contributions and the portfolio of investment options her plan offers I consider mediocre (no index funds). She is set up to contribute the maximum of $17,500 a year through automatic pre-tax deductions.​

So the question is…. Do the tax advantages of participating in a 401K plan with no company match and a mediocre portfolio outweigh the option to opt of the 401K plan and invest those same dollars post-tax into something like index funds? ​

​

Together we make $200k a year and I have my 401k with company match maxed out. ​

I would love to hear the opinions of others on the board.​

 

[pb4uski]

In your case, the play would be whether your marginal tax rate when you withdraw the funds in retirement is substantially lower than your marginal tax rate when you make the contributions while working. In many cases for couples at your income level, your retirement marginal tax rate will be lower and probably substantially lower unless you have good defined benefit pensions, but you'll have to assess that for yourself.

 

[chasesfish]

Yes, you probably are better off contributing the max.


I have an almost identical problem with my wife's simple IRA. It's horrible, high cost loaded mutual funds, but she can contribute $12k tax deferred to that plan verses $5k to a traditional IRA. Our marginal tax rate fed plus state runs 34%

 

[Ready]

Can you share with us just how high the fees and expenses on the funds are?

Also, consider sending a suggestion to HR, or whoever manages the funds, to include a few index funds in the plan. If enough people request it, maybe they will listen. Generally the selection of funds is managed by one individual in a company, and often times they know very little about investing, so they rely on the 401K administrator to make the suggestions.

 

[photoguy]

Together we make $200k a year and I have my 401k with company match maxed out.
I would love to hear the opinions of others on the board.​

​

Tax savings will likely dwarf expense ratios so you are better off contributing.

If the expense ratio is 1% and your tax savings 25%, the breakeven point is about 450k in funds. It will take a long time to reach that.​

 

[growing_older]

You can run examples to see how important lower ER are. In most cases, if you plan to stay at this job no more than 5 or so years, the tax advantages outweigh the higher ER. If you plan to stay longer, the corrosive effects of higher ER will eventually cost more than the tax advantages.

 

[ClockWatcher]

Tax savings will likely dwarf expense ratios so you are better off contributing.

In respectful disagreement, I recommend that you run the numbers for yourself. My DW, who was in a similar position a few months ago, found herself with an S&P 500 index fund with ~1.4% in mutual fund (.56%) and plan (.85%) fees. In our 25% marginal tax bracket, by a small amount, it was actually worse for her to be contributing to the 401(k). (Those of you on this board who helped me with my numbers continue to have my appreciation).

Our subsequent efforts to get the 401(k) plan improved fell on deaf ears as the CEO of her small company does not use it himself and all of the costs are passed on to participating employees. We continue to contribute 50% of the $17,500 allowable maximum, in part to hedge our bets, but also on the possibility that DW may move on to a different company in the near future, with the anticipation of rolling the funds over to her low-fee IRA at that time.

 

[ClockWatcher]

Relevant to this thread is a blog published yesterday by Matthew Heimer at MarketWatch.com:

How much is too much to pay for a 401(k)? - Encore - MarketWatch

...the average fund participant annually pays about 0.71% in mutual-fund fees and 0.13% in administrative and other fees, for a total of 0.84%, or $84 per $10,000 invested.

His data comes from Measuring Fiduciary and Investor Losses in 401(k) Plans by Quinn Curtis & Ian Ayres.

http://www.law.yale.edu/documents/pdf/cbl/CurtisAyres_401kFees(1).pdf

If you are paying substantially more than the numbers above and without a match to compensate, your 401(k) may not be as useful in saving for retirement as you might like.

 

[chasesfish]

The bigger issue is that an employer sponsored 401k has preferential tax treatment over a traditional IRA - the employee can put in over 3x more fax deferred

 

[GrayHare]

A problem with a traditional 401k (and tIRA) is that withdrawals are taxed as ordinary income, historically the category taxed at the highest rate. Thus you pay tax on the gains at the high ordinary income rax rate.

If you expect your ordinary income tax rate to be about the same during your retirement as you pay now, it makes sense to NOT add to a 401k beyond a company match and instead invest the money for growth. If you invest in a growth stock that pays no dividend, here are some benefits: 1) you pay no tax until you withdraw (sell), 2) there are no RMDs, 3) there's no waiting until age 59.5 if you need the money sooner, 4) the withdrawals (sales of stock) are taxed at the capital gains rate, a rate that historically has been lower than the one for ordinary income.

 

[ClockWatcher]

A resource that may prove helpful:

BrightScope | 401k Plan Ratings, Financial Advisor Pages, Better Data for Financial Decisions

After entering the name of a company in the upper right portion of their webpage, Brightscope provides a rating of the 401(k)/403(b) plan and compares it with the plans of other companies. Most companies can be found here, but some of the smaller ones may lack detailed information.

 

[In-control]

I have a similar situation. I work for the State and contribute the max, to a 403B and to a State Annuity both are in the Fidelity Balanced fund. While that is not indexed it has treated me well and the income is tax differed. While they do not contribute I figure that when I do take it out starting @ 59 1/2 my tax rate should be much less lower then what I am paying now.

If I collected it as income now it would increase my tax bracket and cost me more overall.

The system is kinda designed to encourage people to save - which is a good thing.

;-)

 

[Pleeplus]

Thank you for the insights and opinions. After evaluating our tax bracket we have decided to go ahead and continue to max out DW's 401K. By doing this it will keep us in a 28% tax bracket and if she did not contribute we would fall into the 33% tax bracket. The company DW works for is a smaller start up company with <50 employees and total fees on her 401K account range from 1.0% to 1.4% (ouch!). We are also trying to see if we can get some additional investment options in the plan.

 

[growing_older]

Another consideration is that if the company is a smaller start-up you may be able to convince them to transfer to a better plan. Also, as their total 401k plan size grows, additional options may become available as their plan becomes attractive to larger providers. The last little company I worked for was unaware of the effects of high ER on plan participant results, their salesman had strongly focused on administration fees to the business so as long as the fees were borne elsewhere it wasn't part of the decision making to choose a plan. Once I convinced the CFO how expensive it was, they started shopping. That and a few engineers leaving for other companies and citing bad 401k in their exit interviews. Still took about 18 months evaluating proposals to change plans. CFO later said part of that was the overall size of plan was small so fewer providers were interested until the total balances crossed the $2 million mark.

 

[sengsational]

Thank you for the insights and opinions. After evaluating our tax bracket we have decided to go ahead and continue to max out DW's 401K. By doing this it will keep us in a 28% tax bracket and if she did not contribute we would fall into the 33% tax bracket. The company DW works for is a smaller start up company with <50 employees and total fees on her 401K account range from 1.0% to 1.4% (ouch!). We are also trying to see if we can get some additional investment options in the plan.

Although I didn't read every word so far in this thread, I did search the page for 'Roth' and go no hits. IMHO, in almost all situations, maxing both yours and your spouse's Roth is better than even a low expense 401k. So if you haven't considered that, I'd put that into the number cruncher and see how you fare. The 'old thinking' was that you'd be in a lower tax bracket when you retire, so you defer as much as you can (pushing you into the traditional 401k). The current thinking (not saying it's correct or better, but should be considered), is that due to the age profile of the US, tax revenues are going to be "in high demand" in the future, and so when you start pulling out of those tax deferred accounts, you'll get hit pretty hard if you pull enough to have even a little bit classy lifestyle. Anyway, I'd max the Roth, cut back on the crappy employer 401k if it were me.