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401k or taxable account?
Old 08-09-2009, 12:47 AM   #1
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401k or taxable account?

I have a delimma, and I need some advice about the best long term investing strategy. My current situation:

I LBYM on a very small portion of my income. So that leaves most of my paycheck to go into savings of some kind. The first thing that gets funded is my Roth IRA. (usually at the beginning of the year, just to get it out of the way) That leaves about $600 every two weeks that can either go into a 401k or into a long term taxable account. Given the sh****ness of my 401k providers mutual fund options, I am wondering if I should continue investing in it.

John Hancock is the provider for my 401k, and they actually offer index funds, but the er of these are close to 1%

I am currently putting about $600 every 2 weeks into my 401k WITH NO COMPANY MATCH- into the following funds ...
JH Intl Index JEIEX er: .98
JH Small cap index JESIX er: .93
JH Total bond JEBNX er: .93
JH Mid cap index JECIX er: .91
JH S&P500 index JEINX er: .91

Do you all think that I would be doing myself a favor by stopping the funding to my 401k, and instead investing in some Vanguard or Fidelity index funds of the same type in a taxable account?

On the surface, in a taxable account I could easily beat the expense ratios since I can choose from anything I want. But then I would lose my tax deferred status, and then get the cap gains tax (and who knows what else) when I go to withdraw in 2040.

fwiw, my federal tax bracket will not change if I stop contributing to a 401k...or at least, I will contribute enough to a 401k so that it doesnt.)

Thanks for the help.

Mill
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Old 08-09-2009, 12:23 PM   #2
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I would stick with the 401k. Say you tax rate is 30% (25% Fed + 5% state). Contributing $15,600 will save you $4,680 on your tax bill. If you put that $15,600 into a taxable account with an expense ratio of .23 instead of .93, it would only save you $109. There are some benefits to the taxable account, but I don't think they outweigh the tax savings.

Does your 401k have any target retirement date / life cycle funds? A lot of times these will have lower expense ratios.
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Old 08-09-2009, 12:36 PM   #3
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I would stick with the 401k. Say you tax rate is 30% (25% Fed + 5% state). Contributing $15,600 will save you $4,680 on your tax bill. If you put that $15,600 into a taxable account with an expense ratio of .23 instead of .93, it would only save you $109. There are some benefits to the taxable account, but I don't think they outweigh the tax savings.

Does your 401k have any target retirement date / life cycle funds? A lot of times these will have lower expense ratios.
That may be the correct answer, but it's not the complete picture. You have to predict the tax rate when you withdraw the 401K. If it's 15% fed / 5 state, you'll eventually pay 20% tax on that 15,600, or $3120. So you've saved $1560 by staying with the 401K.

Any profit on the $15,600 is probably taxed at 15/5 either way, whether it's taxed later at the lower bracket when you withdraw the 401K, or as capital gains with you withdraw the after tax money.

But that expense ratio is annual, isn't it? So it's $109 (or more as the nest egg grows) each year. You need to do the math on that too, unless I'm looking at this wrong. 10-15 years of fees will eat up that initial tax gain.

Chances are you won't stay with the same company til retirement, so when you leave you can roll the 401K into an IRA with the lower fees and get the best of both worlds.

I suspect when you do the full math the 401K will still probably be correct, but the keys to the equation besides the expense ratio are your current and predicted retirement tax brackets (and cap gains treatment), and number of years you'll have the higher expenses in the 401K.
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Old 08-09-2009, 12:52 PM   #4
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I think I missed a 401K advantage, that you can invest $15600 there, but only 10920 with that same money in an after tax account because of the $4680 tax bill. So you have a larger principal amount to grow over the years, and if that gain will be taxed at the same rate at withdrawal, the 401K does better.
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Old 08-09-2009, 01:22 PM   #5
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Quote:
I am currently putting about $600 every 2 weeks into my 401k WITH NO COMPANY MATCH- into the following funds ...
JH Intl Index JEIEX er: .98
JH Small cap index JESIX er: .93
JH Total bond JEBNX er: .93
JH Mid cap index JECIX er: .91
JH S&P500 index JEINX er: .91
This would be enough for me to seriously consider investing that $1200 each month in the Vanguard TSM. I can not believe that they could have an ER closer to 1% for an "index" fund when VG and others are less than .20% for the same basket of stocks.

Of course, the agent/reg rep has to eat, the JH office has to keep it's lights on, JH has to make a profit, MFC (JH parent) has to make a profit and MFC stockholders (me included) do like to receive that quarterly dividend that rolls in. That's a lot of mouths to feed.
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Old 08-09-2009, 04:43 PM   #6
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This would be enough for me to seriously consider investing that $1200 each month in the Vanguard TSM. I can not believe that they could have an ER closer to 1% for an "index" fund when VG and others are less than .20% for the same basket of stocks.

Of course, the agent/reg rep has to eat, the JH office has to keep it's lights on, JH has to make a profit, MFC (JH parent) has to make a profit and MFC stockholders (me included) do like to receive that quarterly dividend that rolls in. That's a lot of mouths to feed.
Oh trust me, it ticks me off. So much so, that I wrote an email to my company about the er of JH index funds being 6x higher than vanguards competing product. And I didnt drop it after I got the standard auto-response of "thank you for your concern, we'll file that away." I was asked for patience with the issue, and now with this match elimination, Ive about given up on the whole thing.
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Old 08-10-2009, 11:43 PM   #7
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what does everyone think of this?


My employer does not invest in my 401k plan any longer since we have company stock. should i move my 401
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Old 08-11-2009, 08:28 AM   #8
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I think it's horrible advice. First he mentions how stocks are taking a beating so he suggests a money market over stocks. He's suggesting to buy high and sell low! Secondly, he doesn't mention the tax advantages of a 401k which is a major benefit. That to me is really of odd.
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Old 08-11-2009, 08:41 AM   #9
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There's some real shaky advice in there. The one that really caught my eye is the advice to move the 401K money to a money market or fixed income to "prevent any further loss" of this bad market "until the market starts to turn around". This was suggested in late February. The old "Sell low, buy high" strategy. And guess what the market started doing around this time? That part has nothing to do with 401K vs. Roth vs. after tax, but it does give you an idea of how good the rest of the information may be.

The other problem I have is that he says the tax on the 401K could be as high as 35%. While that's true if you have a whole lot of income in retirement, for most of us it won't be. In his example scenario 2 he uses a tax rate of 25% on every dollar of income, but the first 34K (68K for joint filers) is taxed at 15%, and you'll also have deductions, so this is flawed.

Even if the numbers were correct, he doesn't show the numbers for alternatives, including the inflation impact. Why go into such detail on the 401K without showing the same detail on other options? Talking about the buying power of your 401K is absolutely meaningless if you don't compare it to the other options.

A Roth IRA might work out better, but remember that for every $1000 you can invest in a 401K today, you can only invest $700 (assuming 25% fed 5% state) in a Roth or taxable account. Work the numbers for the Roth and see how it comes out in the end vs a 401K. If you're looking for the right answer, you can't just look at some of the factors, you have to include them all.

A Roth IRA is a better option than after tax options if you're looking strictly for retirement since the gains are never taxed. It's worth running those numbers vs. a 401K.
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Old 08-11-2009, 08:56 AM   #10
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Good and bad advice. For instance, the post is dated 2-24-09 and advises to move the equities to stable value or money market in the 401(k). That was not the absolute bottom, but very close to it.
The article points out that the 401(k) should have been more balanced, and that is the good advice.
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Old 08-11-2009, 10:43 AM   #11
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Good and bad advice. For instance, the post is dated 2-24-09 and advises to move the equities to stable value or money market in the 401(k). That was not the absolute bottom, but very close to it.
The Dow was at 7350 on February 24 so his timing couldn't have been much worse. Maybe we should listen to the market timing guys but do the opposite of what they say?
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Old 08-11-2009, 12:04 PM   #12
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Well, I could keep maxing out the 401(k) even with the crappy fund selection, and work on trying to get my HR department to include additional fund options. Down the road, when you switch jobs you can roll your 401(k) over to a rollover IRA and control the investments however you'd like, and that money will stay in a tax-favored account until you retire, which is a big benefit.

Given how often people change jobs these days on average, you may only be looking at a few years of dealing with this crappy plan.
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Old 08-11-2009, 12:10 PM   #13
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I agree with Lusitan. You really shouldn't miss the chance to defer this money. I know I regret the years in my 20s when I didn't fund my IRA or my 401k.
If the options are bad, maybe they'll improve, maybe you'll move jobs. Either way, you've got the money deferred. Don't pass up that chance!
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