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401k->IRA->72t (SEPP) vs. Roth IRA
Old 04-21-2011, 11:35 PM   #1
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401k->IRA->72t (SEPP) vs. Roth IRA

In my other thread here, my 401k investments came up. Right now, I am investing 6% of my income and getting a 3% employer match, and for the first 21 months on my job, I put 3% into the Roth and 3% into my 401k, having 1.5% of the matches go to each (except that the Roth stuff is probably taxed to be less).

Just 1 month ago, I learned about the ability for me to roll my 401k over to an IRA, and then use 72t/SEPP to access that money early and penalty-free. Because of that, I thought it would be best to just go all-in on the 401k and stop investing in my Roth.

Then I learned that whatever I contributed to my Roth could be withdrawn early with no penalty as well. That means less money than my 401k will be available, but it will also be tax-free.

Learning this now has me confounded.

So, I plan to retire at 45, and am aiming to hit $2 million. (So, by the 4% rule, I'd get $80k/year). I am currently 25.

Based on this information, what do you think is the best thing for me to do for my retirement?
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Old 04-22-2011, 12:45 AM   #2
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I think your priorities should be in this order:

1) Roth 401k
2) 401k
3) Roth IRA
4) IRA
5) taxable

The Roths will grow tax free and you can use the principle without penalties. 401ks come before IRAs to get the company match. Do the Roth IRA while you are young enough and have low enough pay to contribute to it.

Taxable is last, and it assumes you already have a sufficient emergency fund. I would say that 4-5 months is not sufficient. However, you could build it a little at a time. I would go to a year (a year of basic, must have expenses. This is for survival, while you look for a new job...save separately for vacations).

As you get older and earn more, you will be able to add more to he taxable. BTW, if you have an acct at Schwab and invest in their ETFs for your taxable, there are no transaction costs and the fees are 0.08-0.15% for their stock funds. Full disclosure: my acct is at Schwab, and I use their ETFs. But I also use Vanguard ETFs thru Schwab. So far, performance for similar funds have been pretty close. They are not made up of exactly the same components so you will see variances day to day, but over time they have been very close.

R
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Old 04-22-2011, 07:16 AM   #3
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I agree with Rambler except for one caveat....

You might want to flip 1 and 2 according to your tax situation.... if you are in a HIGH tax bracket, then the tax savings can make up for the earnings being taxes (at a lower rate hopefully)....

It also allows you to convert to ROTH later in life if the timing and taxes are right..

I also think that 1 and 3 are the same in terms of savings.... but you can control 3 more than you can 1.... most 401(k) plans do not have many good options where an IRA is wide open in choices...
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Old 04-22-2011, 07:23 AM   #4
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Quote:
Originally Posted by studbucket View Post
..........So, I plan to retire at 45, and am aiming to hit $2 million. (So, by the 4% rule, I'd get $80k/year). I am currently 25...........
4% may be a bit much at age 45
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Old 04-22-2011, 08:23 AM   #5
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i'm a strong believer in roths. MAINLY because they help you to save "more." Sure, $2MM is $2MM. But, what would you rather have? $2MM in roth funds or $2MM in taxable funds? A chimp could make that decsion. Of course, there may be a tax penalty for doing so...there may not be. no one knows.

when my number is called, I plan to initiate a 72(t). the gubmint is very conservative and very interested in making sure your economic early retirement experiment is successful, so i wouldn't plan for a 4% SWR, at least with the funds you will be withdrawing for a 72(t). the catch with the roth IRA money is there are ways to get by the RMD's when you are older and ways to pass on down through the generations. My primary goal is to make retirement stick once i take the plunge and then to maximize hand me downs for posterity. point is, there are many considerations....

for reference, I just turned 28 and my NW is over $260K, approaching $400k if you throw in the house, and my "monte carlo lite" simulation shows about half of the market return scenarios getting me to $2MM by age 45. i've found maxing my 401k (roth), and ROTH IRA's for both me and the wife to be difficult (it is the equivalent of saving $2208/month after tax). It is possible, and we are able to do it, but very few of my peers at w*rk do so. This will be the first year we invest in taxable accounts...and the confusion is abounding.

have you gone to your library and checked out the boglehead's investing book? i recommend you do so if you already haven't.
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Old 04-22-2011, 12:21 PM   #6
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Quote:
Originally Posted by Rambler View Post
I think your priorities should be in this order:

1) Roth 401k
2) 401k
3) Roth IRA
4) IRA
5) taxable

<SNIPPED>

R
Quote:
Originally Posted by Texas Proud View Post
I agree with Rambler except for one caveat....

You might want to flip 1 and 2 according to your tax situation.... if you are in a HIGH tax bracket, then the tax savings can make up for the earnings being taxes (at a lower rate hopefully)....

<SNIPPED>
Thanks to both of you, that's helpful and informative! I'm very much a financial rookie, but I'm trying to do things right, which leads me to another question.

What do you mean by taxable? Is that my investments in Index funds, savings accounts, etc?

Quote:
Originally Posted by travelover View Post
4% may be a bit much at age 45
So, I read the monster thread on the "4% rule" on these forums and searched around online. My impression was that it was a "magic number" of sorts, where if you withdrew that much and adjusted for inflation each year, you could basically go on indefinitely.

I'm more than happy to withdraw less (if that's what makes the most sense), but I was under the impression that 4% was a good target.

Quote:
Originally Posted by ronocnikral View Post
<SNIPPED>
for reference, I just turned 28 and my NW is over $260K, approaching $400k if you throw in the house, and my "monte carlo lite" simulation shows about half of the market return scenarios getting me to $2MM by age 45. i've found maxing my 401k (roth), and ROTH IRA's for both me and the wife to be difficult (it is the equivalent of saving $2208/month after tax). It is possible, and we are able to do it, but very few of my peers at w*rk do so. This will be the first year we invest in taxable accounts...and the confusion is abounding.

have you gone to your library and checked out the boglehead's investing book? i recommend you do so if you already haven't.
Thanks to you too! It sounds like you are doing really well.

Right now my wife is staying at home taking care of our daughter, and she will work someday (she wants to), maybe even after I retire, but I'm trying to do all my planning as if my income was the only one that mattered. Given that, my 401k/Roth + employer match is only $800 or so a month, though it will get higher 5 months from now as my company just announced pay raises that will net me a 15-20% gain.

Given that, I view the 401k as a supplement to what I want to do, not the primary vehicle. I just want to make sure that I'm doing the best thing with this "easy money".

It sounds like I should just make the 401k Roth contributions as much as I can, until I make too much money, then I go to the regular 401k. When I retire, those will be viewed as 2 separate accounts, right?

Anyway, for the rest of my retirement fund, I'm currently paying down all debt, but have spreadsheets mapping a lot of stuff out, and am going to try to start investing using Merriman's Ultimate Buy & Hold suggested allocation.

My wife's picking up some books (possibly the Boglehead one) from the library right now. So I'll read it if I get the chance, but she will definitely read it and try to share the knowledge.
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Old 04-22-2011, 12:45 PM   #7
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Regarding my 4%/SWR question, Midpack helped me out over here: Never ending SWR & FIRECALC
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Old 04-22-2011, 01:33 PM   #8
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I thought the basic question when deciding between Roth and "deductible" (IRA or 401K)
was your tax bracket now vs when you withdrew the funds. You can demonstrate that if the brackets are the same, then the Roth is better if you can maximize contributions. If your bracket now is higher than when you withdraw, that favors the "deductible" account. If the bracket now is lower than when you withdraw, that favors the Roth. You may not know exactly what will happen, but you need to take your best guess.

If you get 80K when you retire, that sounds like a 15% bracket today (who know what it will be tomorrow). What is your tax bracket today?
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Old 04-22-2011, 01:48 PM   #9
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I thought the basic question when deciding between Roth and "deductible" (IRA or 401K)
was your tax bracket now vs when you withdrew the funds.
That is a question, and in my mind, an uncertainty that no one can quantify the risk for. For someone under 30, it is almost a no brainer (imo of course) to contribute ROTH money. Exceptions apply, and each case is different, but I've given my reason above and it is independent of current and future tax rates.

Each may do as they please...most young people end up doing nothing...
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Old 04-22-2011, 01:51 PM   #10
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I thought the basic question when deciding between Roth and "deductible" (IRA or 401K)
was your tax bracket now vs when you withdrew the funds. You can demonstrate that if the brackets are the same, then the Roth is better if you can maximize contributions. If your bracket now is higher than when you withdraw, that favors the "deductible" account. If the bracket now is lower than when you withdraw, that favors the Roth. You may not know exactly what will happen, but you need to take your best guess.

If you get 80K when you retire, that sounds like a 15% bracket today (who know what it will be tomorrow). What is your tax bracket today?
I am currently in the 25% tax bracket (between $69,000 & $135,350).

Based on Midpack's thread, I may want to take out $64,000, not $80,000 (as 64k would be 3.2% of my goal $2mil portfolio). That would likely be the 15% tax bracket (though 20 years is a long time, and a lot can change). I will also likely make it to the 28%, or even 33% tax brackets before I retire.

I guess that lends itself to the 401k? Of course, if my wife works when I retire, that's a confounding factor (unless we just live off her income and I don't touch the retirement savings).
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Old 04-22-2011, 02:10 PM   #11
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Quote:
Originally Posted by ronocnikral View Post
That is a question, and in my mind, an uncertainty that no one can quantify the risk for. For someone under 30, it is almost a no brainer (imo of course) to contribute ROTH money. Exceptions apply, and each case is different, but I've given my reason above and it is independent of current and future tax rates.

Each may do as they please...most young people end up doing nothing...
I totally get the draw of the Roth, and a lot of people wiser than I are saying to invest in the Roth, but I want to understand why I'm doing what I'm doing. Look at the scenario below:

Regardless of whether or not I'm investing into Roth or 401k, they're getting the same returns, so here's a theoretical state of them when I retire.
Principal: $220,000
Gain: $330,000
Total: $550,000

So, that's 1/4 of my total portfolio. If I use the 72t/SEPP, according to an online calculator, that would be $24,000 of the $64,000 I need each year (37.5%). If that's taxed at 15%, $20,400 I get. When I hit 60 and SEPP ends, the balance of the 401k would be $400,000. It also means I'm not drawing as much from my other investments, as I only need them to make up 62.5% of my FIRE income, not 75%.

If I use the Roth, I can withdraw as much as I like, as long as it's only part of the $220,000 I put into the principal. Let's say I want to suck that dry and use up all the principal until I'm 60 and can access all of it. That's $14,667 of the $64,000 I need each year. It's not taxed, and will represent 22.9% of what I need, a little less than the 25% of my portfolio that the Roth comprises. I'm unsure of how to calculate how much I'll left in that account, as the $330k+ will be making money, but I'll just go ahead and assume it'll be higher than the $400k in the first scenario.

Looking at the numbers, neither scenario strikes me as especially better than the other, and this doesn't help me make my decision like I thought it would

So, what am I missing, where is my math wrong?

Thanks for the help and discussion!
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Old 04-22-2011, 02:30 PM   #12
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Uncertainties abound......and may overwhelm the logic and math in the end.......but still there should be some reasoning involved:
e.g. in the 25% bracket in earnings years
A) puts 5K in "deductible" 401K or TIRA, pays no taxes on that, has a 1.25K taxable side fund (25% of 5K). N yrs later, funds have doubled . Has 10K in tax deferred, 2.5K in taxable. Now in 15% bracket, has after tax 8.5K from tax deferred and 2.3K in taxable for total of 10.8K.
B) put 5K in Roth account. Has to pay taxes at 25% on that income so wipes out the taxable side fund. N yrs later, funds have doubled to 10K and have after tax value of 10K .

Because of the unknowns, you could choose to hedge and do both, but basically this is a quantitative decision although there are certainly all kinds of other qualitative factors that you could drag in......
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Old 04-22-2011, 02:39 PM   #13
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So, what am I missing, where is my math wrong?

Thanks for the help and discussion!
I know nothing about how the 72t works quantitatively so you're way over my head......but somewhere in your calculations you need to take into account that for the deductible account, you aren't paying taxes on that contribution whereas you are for the Roth. That means there will be a taxable side account when you have the deductible account that you won't have when you have the Roth.
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Old 04-22-2011, 02:48 PM   #14
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@kaneohe: No worries about not understanding 72t, I used an online calculator to get the numbers

All of my research so far hasn't really considered taxes very much, and I'm not sure how they will affect my assets 20-60 years from now. I get how taxes affect me today, as a 25-year old, but I don't know their impact on my assets when I retire. Is there a good summary somewhere so I could educate myself?
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Old 04-22-2011, 02:48 PM   #15
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one incorrect assumption studbucket is making is that you can withdraw roth 401k funds penalty free. it is true for IRAs, but not neccessarily for your 401k. check with your plan rules. if i was a betting man, i would say there is some penalty associated with early withdrawl of roth 401k funds unless under a special rule (e.g. 72(t)).

as kaneohe says, hedging is where most people end up. I'm almost exactly 50% roth and 50% trad. this is because i started contributing when i was 20 as an intern and had a few years of full time work under my belt before a roth 401k was available, in addition to my company's generous 8% immediately vested match.

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That means there will be a taxable side account when you have the deductible account that you won't have when you have the Roth.
that's only true if the person has the discipline to do so. my highly unscientific research shows this to be highly unlikely amongst those in their 20's. this is what i mean when i say someone is able to invest "more."
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Old 04-22-2011, 02:51 PM   #16
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one incorrect assumption studbucket is making is that you can withdraw roth 401k funds penalty free. it is true for IRAs, but not neccessarily for your 401k. check with your plan rules. if i was a betting man, i would say there is some penalty associated with early withdrawl of roth 401k funds unless under a special rule (e.g. 72(t)).
Interesting, I'd never considered that a Roth 401k may be treated differently than a traditional Roth IRA. That could change everything.

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as kaneohe says, hedging is where most people end up. I'm almost exactly 50% roth and 50% trad. this is because i started contributing when i was 20 as an intern and had a few years of full time work under my belt before a roth 401k was available, in addition to my company's generous 8% immediately vested match.
That's exactly what I was doing for my first 21 months here at work. Now, in my 22nd month, I thought I had it all figured out (whoops ) and I went 100% into the traditional 401k and have nothing going into the Roth.
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Old 04-22-2011, 03:13 PM   #17
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I'm having a hard time getting the Roth 401k answer...searches turn up unhelpful websites which make me think that that I can't access the Roth funds, our hr website doesn't tell me anything, but the Fidelity site has this text at the bottom:
2009 is the first Roth Contribution Year
2014
is the first year a tax-free Roth withdrawal may be available.


So, maybe I can access it without having to roll it over into a Roth IRA. Either way, I should email HR or Fidelity to see if they can help.
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Old 04-22-2011, 03:59 PM   #18
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So, it may not be perfect, but using some online calculators found here and here, it appears that, for me at least, I'll come out a little bit ahead in the long run with a traditional 401k.

It's pretty close though, so I wouldn't consider this conclusive, but at least it's quantitative.
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Old 04-22-2011, 06:07 PM   #19
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one incorrect assumption studbucket is making is that you can withdraw roth 401k funds penalty free. it is true for IRAs, but not neccessarily for your 401k. check with your plan rules. if i was a betting man, i would say there is some penalty associated with early withdrawl of roth 401k funds unless under a special rule (e.g. 72(t)).

as kaneohe says, hedging is where most people end up. I'm almost exactly 50% roth and 50% trad. this is because i started contributing when i was 20 as an intern and had a few years of full time work under my belt before a roth 401k was available, in addition to my company's generous 8% immediately vested match.



that's only true if the person has the discipline to do so. my highly unscientific research shows this to be highly unlikely amongst those in their 20's. this is what i mean when i say someone is able to invest "more."
I googled this Roth 401(k) Withdrawal Rules | LIVESTRONG.COM You'd need to dig more to get confidence but it sounded like you had access once you left the company.

there were a lot more but this one had a relatively recent date (2010).

r.........I have no doubt of your last observation being true in the general population but perhaps there is some self-selection of those who come here that would bias the results the other way. I wouldn't be surprised but no data.
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Old 04-22-2011, 06:08 PM   #20
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s......here's a useful site . You could post your questions in the retirement subforum
Fairmark Forum
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