Should I Do After-tax Contribution?

[Tommy_Dolitte]

I will have maxed out my annual allowable pre-tax 401-K contributions in about a month.  

Should I take all of that and dump in my mutual funds *Roth has been maxed since Jan 1.*?    

Pardon me     ...I've just started reading Bernstein and Bogle. Would appreciate some "accelerated" insight.

Thanks,
TD    

 

[Bob_Smith]

Tommy, my wife and I did the same thing you're doing - maxed out our workplace retirement plans and IRAs, and then poured the rest into a taxable account at Vanguard.

Now that I'm ER'd, it's nice to have a taxable account that will carry us to age 62 without needing to delve into the complexities of 72t withdrawals. When we were younger, having those taxable funds to draw on for emergencies eliminated the fear of putting all that money out of reach until age 59 1/2.

 

[azanon]

Unless you just really really hate your job, i dont advise exceeding 401(k)s + Roths.  For my wife and I, that would be 13,000 allowed in 401(k) + 3000 each for Iras.   For our annual income of 92,500/year, 19,000/year earmarked specifically for retirement (for someone with my annual salary) is MORE than enough for even a very aggressive ER minded person. (that would be a touch over 20% gross)   For me, that is to say nothing of the 5% match, my federal pension, and SS suppliment i get for retiring pre-62. Surely, it gets silly at some point.

One of the beauties of compounded growth is how powerful the "time" factor is.  There becomes a point of diminshing returns, especially once the tax benefit is eliminated, to saving very excessive amounts because you dont allow for time to do its magic.  

What i mean is the more you save, the harder you have to work to get less and less earlier retirement.  Run some models and see that it is true, that the more you save, the less extra years of early retirment you get as you increase contributions.  Surely, at some point the tradeoff isnt worth the sacrifice.

 

[brewer12345]

Hmmm, I gotta disagree, azanon. There are a few important things at work here:

- The more you are used to saving, the less you spend. Trite, but also important. The fastest way to speed up FIRE time is to slash your required withdrawal, not by saving more. Lucky for us, increasing savings does both.

- 401k plus Roth is great, but having some additional savings set aside in a taxable account offers you a lot more flexibility. Taxable accounts can be tapped any time without jumping through penalty hoops and can be invested in things that will not qualify for retirement accounts. If all your assets are sheltered and you are offered the real estate (art, gold, whatever) deal of a lifetime, you are SOL.

- Finally, extra savings may not dramatically slash time to FIRE, but it does speed things up.

 

[azanon]

- The more you are used to saving, the less you spend.  Trite, but also important.  The fastest way to speed up FIRE time is to slash your required withdrawal, not by saving more.  Lucky for us, increasing savings does both.

That is true, but still the collective benefit of saving more, yields less and less earlier months/years of ER as you increase contributions, esp when the tax sheltered savings vehicles are exhausted.

- 401k plus Roth is great, but having some additional savings set aside in a taxable account offers you a lot more flexibility.  Taxable accounts can be tapped any time without jumping through penalty hoops and can be invested in things that will not qualify for retirement accounts.  If all your assets are sheltered and you are offered the real estate (art, gold, whatever) deal of a lifetime, you are SOL.

Two points i'd counter with here:

>I'm not against taxable savings, per se.  You do need them for emergency funds, long-term savings (but not necessarily as long term as retirement), etc.  Case in point: i have a taxable utility fund i'm using to save up to buy my next car with cash, for example.

>Its easy to forget and/or not realize that all Roth contributions can be withdrawn at any time, for any reason, without penality (because the IRS got their share initially).  Furthermore, the interest can be withdrawn for a variety of qualifying reasons.

- Finally, extra savings may not dramatically slash time to FIRE, but it does speed things up.

I indirectly acknowledged that with my first response;  saving more = earlier retirement, obviously.  

What i'm suggesting though is that what are we all after here?  In a narrow sense, yes I know, retiring early. But why? To maximum pleasure of life and/or minimizing pains of life, right? My point was that I think you can get to the point that maybe you can save so much that you're causing yourself more pain now than will be balanced out with the pleasures of retiring that much earlier later for having done so.  So.... the trick is finding that right point for you.  My guess is, that for most people (except for those that really hate their job), they'll find a sweet spot within the realm of the allowable tax-advantaged savings.   Granted, this doesnt apply if you make so much, you dont qualify for Roths.

 

[brewer12345]

What i'm suggesting though is that what are we all after here?  Maximum pleasure of life and/or minimizing pains of life, right? My point was that I think you can get to the point that maybe you can save so much that you're causing yourself more pain now than will be balanced out with the pleasures of retiring that much earlier later for having done so.  So.... the trick is finding that right point for you.  My guess is, that for most people (except for those that really hate their job), they'll find a sweet spot within the realm of the allowable tax-advantaged savings.   Granted, this doesnt apply if you make so much, you dont qualify for Roths.

I think we are dancing around basically the same points here. It just seems to me that more savings is better than less, provided it does not require undue sacrifice on one's part.

 

[Hyperborea]

That is true, but still the collective benefit of saving more, yields less and less earlier months/years of ER as you increase contributions, esp when the tax sheltered savings vehicles are exhausted.

I would suggest playing with Firecalc in the way that I suggested in the thread "A New Twist on Firecalc". http://early-retirement.org/cgi-bin/yabb/YaBB.pl?board=young;action=display;num=1093301458;start=2 I used an initial account of $1, 20 years of portfolio life, -$19K / year "withdrawal", no changes, and a 90% equity / 10% commercial paper split. You have to start with a non-zero amount or Firecalc barfs even though the first "withdrawal" is actually a contribution.

Try running your savings numbers through it and see where your savings plan gets you in 20 or 30 years. Yeah, if you save $19K / year for 20 years you will on average have $1.2M. However there are plenty of years where you would only have ~$500K. Remember that these portfolio values are not adjusted for inflation. That means that with a mild 3% inflation the average amount is now $664K and the lower numbers are $276K. Not quite good enough for retirement.

Oh, you want to go for 30 years. Ok that improves the numbers a lot but by then are you really retiring "early"? You may have been 30 (or more) when you started planning for FIRE and that makes retirement at 60 (or more).

My guess is, that for most people (except for those that really hate their job), they'll find a sweet spot within the realm of the allowable tax-advantaged savings.   Granted, this doesnt apply if you make so much, you dont qualify for Roths.

Heck, if I limited myself to tax advantaged accounts I would have to slash my savings to a small fraction of what I save now. I'm not really skimping on my life either. I don't have a million toys that clutter my garage nor do I get a new car every 3 years but I do travel on regular basis, I've got a nice home, I have some "toys" that I do want and use (a couple of guitars, an iPod, etc. etc.). I think the big difference may be between those earning a "significant" amount and those not. Once your income goes over a certain amount a lot of it can be pure savings without really sacrificing anything.

 

[Bob_Smith]

Unless you just really really hate your job, i dont advise exceeding 401(k)s + Roths.  For my wife and I, that would be 13,000 allowed in 401(k) + 3000 each for Iras.   For our annual income of 92,500/year, 19,000/year earmarked specifically for retirement (for someone with my annual salary) is MORE than enough for even a very aggressive ER minded person. (that would be a touch over 20% gross)   For me, that is to say nothing of the 5% match, my federal pension, and SS suppliment i get for retiring pre-62.  Surely, it gets silly at some point.

I also disagree. Saving $19,000 per year for retirement isn't enough for most people who want to have a reasonable hope of ER, unless they have a pension sufficient to meet the shortfall (which you appear to have). But for those with no defined benefit pension (most) limiting their saving to $19,000/year would mean working until 65-70. For example, it would take 48 years to accumulate 1 million (in today's dollars) with inflation at 4% and a return of 7%. Bump up the return to 9% and it would still take 35 years, and I wouldn't count on a 5% real return going forward. Furthermore, it's a very rare young family that can save anything right out of the starting gate. There are school debts to pay, a home and cars to buy, etc. And someone with a $92,500 income/$19,000 savings plan would appear to be planning to support a $73,500 lifestyle, so 1 million wouldn't be enough. It may get silly at some point, but for most people that point wouldn't be $19,000 per year.

 

[cute fuzzy bunny]

In a word: yes.

Increase your after tax investment savings until the cut into your lifestyle starts to become mildly annoying. Then increase it another 10%. As you receive salary adjustments, put the entire adjustment into it as well.

 

[ats5g]

Tommy,

It seems that you have extra $$ to save, and you're not sure where to put it: After Tax contributions to 401(k) or in a taxable account? If you're going to invest in equities, I'd favor the taxable account for a number of reasons

1) Investment Choices - I don't know what your 401(k) choices are, but you may have much more freedom of choice in a taxable account. You don't have to worry about the 401(k) plan committee changing your choices for you. Also, some 401(k)'s can charge higher fees (admin + expense ratios) than a taxable account.

2) Capital Gains vs. Ordinary Income tax rates - If you can invest in a tax efficient equity fund (like a Total Stock Market fund for example), you'll probably get a higher after tax return b/c all the long term cap gains and qualifying dividends in the after tax 401(k) will be taxed later at higher ordinary income tax rates.

3) You won't be able to tax loss harvest with the after tax 401(k) money.

4) This is more long term thinking, but taxable accounts have no RMD's, and (under current tax law) when you die your heirs can get a stepped up basis on your taxable securities. The stepped up basis favors equities mostly.

I'm surprise no one mentioned this yet.

- Alec

 

[azanon]

I"ve gotta admit you guys are pretty inspirational.  I'd be embarressed to tell most people I sock away 19K a year for retirement alone (from 92.5), let alone anything higher.  Even at that figure, i'm well beyond most people.

Its really tough for me now to even save that much at my age, due to mortgage, a school loan, and the wife's car payment atm.  I also have a new one year old.  I think as i get older and eliminate those loans i have i'll be able to ratchet up the percentage and maybe make up some lost ground.

(Hyper, in your analysis of my situation above, you seem to have forgotten my 5% match, my pension, and my SS suppliment, to say nothing of the 60K i've already saved. Those items changes things a little /wink).

 

[cc]

If you stop at the pre-tax limit, make sure you don't lose any matching contributions in your plan.

My plan matches the first 6% each pay, so I have to continue with after-tax contributions after hitting the pre-tax limit or I lose the match...

 

[azanon]

That doesnt sound good.

In the Federal system (TSP/FERS), they match up to 5%, so you only have to put in 5% of your own funds to get the match. Beyond that, the contribution limit this year is 14% of gross, that will get 401(k) type benefits.

 

[unclemick]

To recap:

1. The earliest $ are the best $ - taxable or tax deferred.
2. Once a tax deferred year passes it's gone.
3. Youth is wasted on the young - do the young stuff now - just -ala TH - don't overconfuse youth with $. Try to make a realistic trade - off - Lifestyle now/ ER vision.

 

[Hyperborea]

(Hyper, in your analysis of my situation above, you seem to have forgotten my 5% match, my pension, and my SS suppliment, to say nothing of the 60K i've already saved.  Those items changes things a little /wink).

Sure they change things for you a little /wink. However, your savings "plan" wasn't just what you were doing but you were giving it as specific advice to Tommy_Dolittle and as generic advice to anyone planning FIRE.

My guess is, that for most people (except for those that really hate their job), they'll find a sweet spot within the realm of the allowable tax-advantaged savings.

Does Tommy_Dolittle have a 5% match? Does he have a pension? Does he already have $60K saved? Does everybody else saving for FIRE have those?

I know that I've got a good match and I certainly have a good deal more than $60K but I like most people under 40 (or maybe 50) don't have a pension. A pension changes things incredibly and to suggest that those without one can save in the same manner as those with is irresponsible.

 

[Bob_Smith]

Its really tough for me now to even save that much at my age, due to mortgage, a school loan, and the wife's car payment atm.  I also have a new one year old.  I think as i get older and eliminate those loans i have i'll be able to ratchet up the percentage and maybe make up some lost ground.

For a young person, saving $19,000/year is phenomenal! I don't know exactly how old you are, but you're far ahead of where I was in my 20s and early 30s. I think most people go through financial life cycles. For me it started with the destitute college years. Then the early married years with college debts, babies, apartments, salvation army furniture, etc. Then the mortgage, the second car, better furniture, central instead of window air, an occasional vacation... and just keeping our head above water while enjoying life. Eventually there came a time when the income exceeded the expenses and the race was on. It took 13 years and I was 38 when we started saving. Could we have started earlier? I don't think so - there just wasn't enough extra to make a big difference.

Saving $19,000/year would have been WAY over the top for me in my 20s and early 30s, and if you're in that age range and are able to save that much, you're doing far better than I was able to do at your age. But I got there anyway.

 

[Hyperborea]

For a young person, saving $19,000/year is phenomenal!

Hmmm, I don't want it to appear that I don't think that saving $19K /year isn't good particularly at 30. I was just pointing out that it isn't likely to be enough for early retirement for most without pensions particularly if you take into account that SS may not exist for the sub-40 year old.

 

[newellcr]

Hyperborea,

I'm not sure I understand your comments about Azanon. Those particulars (company match, pension, initial savings) you mention applied to him, not as advice to TD, and he shared that info because you evaluated his plan as being 'not quite good enough'.

If TD, or any other poster wants good input, they should include good details. TD didn't provide too much info, maybe he figured folks would remember from his other posts, dunno. Azanon's advice to TD was against post tax savings and he described his reasons for suggesting this. From what I remember about TD, he's younger. Using Azanon's advice, here is a scenario for you. Age 25, savings $16k/yr for 25 years with a real 7% return gives him roughly $1050k in today's dollars (using some quick shortcuts). Age 50 with $1.05 mil with a wr of 4% gives $42k/yr - that sounds like ER success and those figures assume TD didn't have any initial savings amount. I'm not sure how Azanon's advice was irresponsible.

Cheers,

Chris

 

[Bob_Smith]

Hmmm, I don't want it to appear that I don't think that saving $19K /year isn't good particularly at 30.  I was just pointing out that it isn't likely to be enough for early retirement for most without pensions particularly if you take into account that SS may not exist for the sub-40 year old.

Yep, I agree with you. $19K/year would rarely be enough for those who wish to ER, even those starting to save at a young age. At some point that amount would need to be increased, which would involve contributing to taxable accounts.

 

[Hyperborea]

Using Azanon's advice, here is a scenario for you.  Age 25, savings $16k/yr for 25 years with a real 7% return gives him roughly $1050k in today's dollars (using some quick shortcuts).  Age 50 with $1.05 mil with a wr of 4% gives $42k/yr - that sounds like ER success and those figures assume TD didn't have any initial savings amount.  I'm not sure how Azanon's advice was irresponsible.

Well, let's use Firecalc and see what it says. Using your scenario Firecalc with 100% equities (not much different if 90%) says an average of $1.9M but with inflation of only 3% that becomes $0.9M and with a more likely 4% you have $0.7M. The min appears to be $528K which after inflation is only $251K or $198K depending on inflation. Your estimate is high even for the average.

The advice is irresponsible from the point that Azanon is suggesting that "hey $19K is enough cause it's all I can save and golly I'm sure gonna be fine (but I've got a pension that's gonna provide 60% or more of my final year's pay /wink)". It's like suggesting that everyone can make a million in highly leveraged real estate in 7 years. Or perhaps me suggesting that the average joe can save enough for FIRE in 9 years from their salary.

For those who are single or married without kids and saving for FIRE then doing as much as possible now would be of particular benefit. It puts that money aside for major compounding and in many cases they will have kids at some point and that will suck up a lot of the extra income they were able to save.

 

[Tommy_Dolitte]

Thanks for the feedback guys.  Here are some of the details I'd left out.

Age = 28
Current investment totals = $147 K
6% company match on 401-K...

Future wife and I plan to live on $3000/mon *all expenses*--target saving 50-57% of gross.  

She has about $7,000 saved/invested---25 years old.

Targeting kids when she is 27/28....

TD

 

[trumpeting_angel]

Great savings! I'm amazed.

Good to do it now! It won't be quite so easy when the kids come along.

Anne

 

[newellcr]

Hyperborea,

Ok, you used firecalc, that's great. It isn't the definitive tool of how a portfolio will grow in the future. It isn't any more accurate than using one of the old "how $100/mo grows when invested" and handicapping the return by subtracting inflation which is what I did. I never played around with firecalc as an accumulation tool. It sounds interesting. I'll have to tinker some day.

I can't speak for Azanon, but from where I stand you are making some leaps concerning what he wrote. Take a look at the posts in order and maybe you can see this. Then again, maybe I'm reading it wrong. Azanon mentioned his pension when you poo pooed his plan. He replied to your post, that's all. As I mentioned before, if the details aren't there, good advise is hard to administer. Maybe Azanon remembers facts about TD's previous posts. It just seemed unusually harsh to call Azanon irresponsible.

As far as pensions go, the days are mostly gone of leaving in ER with 60% of your high salary. Maybe a 40 year worker, but this starts moving away from the early part of ER.


--------------
TD,

Didn't mean to pick on you about not posting details. Hope you didn't take it that way. Nice totals and savings rate - great job. I'm sure you'll get some good input. Azanon makes some good points about diminishing returns on extra savings in his first post. I'm see this in my own projections now that I'm getting a little closer to ER.

Cheers to all,

Chris

 

[John Galt]

Hey, I agree that FIRECALC is not necessarily the be all-end all predictor, but I enjoyed running the numbers.
I waited for a while and then plugged in some data.
The results were pretty interesting, although I am not
planning my future around them. I'm a simple guy
like unclemick. Interest and dividends is real money.
Future stuff is all "maybes"

John Galt

 

[Hyperborea]

Ok, you used firecalc, that's great.  It isn't the definitive tool of how a portfolio will grow in the future.  It isn't any more accurate than using one of the old "how $100/mo grows when invested" and handicapping the return by subtracting inflation which is what I did.

Actually, I think it is a lot more informative.  The simple compound interest exercise ignores volatility and you get overly optimistic results. You might be close though still a little high for the average but you'll be way too high in perhaps 25% of the cases.

I can't speak for Azanon, but from where I stand you are making some leaps concerning what he wrote.

Look, I don't want to get so wrapped up in this but let's look at his first post where he made the recommendation to not save the money.

azanon:

Unless you just really really hate your job, i dont advise exceeding 401(k)s + Roths.

And then later on he said:

azanon:

My guess is, that for most people (except for those that really hate their job), they'll find a sweet spot within the realm of the allowable tax-advantaged savings.

So unless I was misreading he really did mean that nobody (unless they really hate their job) should save more than they can fit into tax advantaged accounts.

It just seemed unusually harsh to call Azanon irresponsible.

Fine, I can chose another word.  How about "misguided"?

As far as pensions go, the days are mostly gone of leaving in ER with 60% of your high salary.  Maybe a 40 year worker, but this starts moving away from the early part of ER.

Well, ok what would a 20 or 30 year worker get these days?  My dad's got a pension but very few people of my age (Gen-Xer) or younger (the boomer echo / Gen-Y) are going to see one unless they have a government job.  However, even getting 25% of my current salary in a pension would be great as that's about what I plan to retire on (unless I decide on an even lower amount - see the "Costs of a Perpetual Traveller Lifestyle" thread).  For others who want/need a higher %age of their salary in retirement a pension can be a big step towards that.  In fact it provides such a great advantage that one can probably get by with only saving whatever they can fit into their tax advantaged savings accounts.