Max out 401k just prior to ER?

[nanannjen]

I read something in a magazine that made me think....it suggested that you may only want to contribute enough to the 401k to get your company match, and save the rest in a taxable account. The logic behind this was that tax rates are low now compared to what they will be.

Since I firmly believe that taxes will only be increasing, this actually made sense to me. We are looking to ER next spring. We have always maxed out on our contributions, but I'm wondering if I should drop it back for the last few months.

Obviously this would require saving (not frittering away) the money....I'm not worried about that portion of it.

Any thoughts? Thanks!

 

[kyounge1956]

I am reading a book (The Retirement Challenge—Will you Sink or Swim?) that suggests the same thing in some circumstances. According to the author, if your 401K plan has high fees and administration expenses, and/or the available investment options are poor quality, you may actually come out ahead by contributing only enough to the tax-deferred plan to get the employer match, and putting the rest of your savings in a taxable account.

 

[jimnjana]

I would not max out my 401k(TSP) the last two years before I retired if I had it to do over again. Cash is king, if after a year or two of retirement if you didn't have any unexpected expenses, you can always invest it. In my cases, not having the cash on hand required me to sell stocks at a loss, which I otherwise would not have done. Your plans may change once you retire, having extra cash on hand, allows you to adjust on the fly. In our case, buying a vacation rental was not a part of our retirement plans...
Jim

 

[travelover]

Future tax rates are unknown, but likely to increase. You probably have a better handle on your future income. In my case, I knew that I'd never have the income in retirement that I had prior to retirement, so I deferred all the taxes that I could by maxing out my 401(k). My assumption is that once my DW retires also, we'll be in a lower tax bracket.

 

[kyounge1956]

I would not max out my 401k(TSP) the last two years before I retired if I had it to do over again. Cash is king, if after a year or two of retirement if you didn't have any unexpected expenses, you can always invest it. In my cases, not having the cash on hand required me to sell stocks at a loss, which I otherwise would not have done. Your plans may change once you retire, having extra cash on hand, allows you to adjust on the fly. In our case, buying a vacation rental was not a part of our retirement plans...
Jim

The tax-deferred plan at my job has various options for saving cash or equivalent inside my account. Also, I am planning to sell my home and buy a less expensive place on retirement, so I'll be able to fill up a "cash bucket" at that time, even if I don't change anything beforehand. However I agree that cash in hand is a good thing to have, and if those options are unavailable, putting a bunch of cash away outside a 401k right before retirement sounds like a prudent thing to do.

 

[DJRR]

I read something in a magazine that made me think....it suggested that you may only want to contribute enough to the 401k to get your company match, and save the rest in a taxable account. The logic behind this was that tax rates are low now compared to what they will be.

I don't buy that logic. I would optimize based on the current tax structure. Future taxes could easily be spending based, like a VAT or a sales tax, and that would mess up your plans.

Unless you have a bad 401k plan I would max it.

Are you 59.5? In that case you can pull out your contributions penalty free so you can have a tax free savings account until you want to withdraw them. You can keep it in the cash option if you are concerned about risk.

 

[IBWino]

I don't buy that logic. I would optimize based on the current tax structure. Future taxes could easily be spending based, like a VAT or a sales tax, and that would mess up your plans.

Unless you have a bad 401k plan I would max it.

Are you 59.5? In that case you can pull out your contributions penalty free so you can have a tax free savings account until you want to withdraw them. You can keep it in the cash option if you are concerned about risk.

Very good point! In fact, here in California, this is being discussed now.

 

[teejayevans]

I read something in a magazine that made me think....it suggested that you may only want to contribute enough to the 401k to get your company match, and save the rest in a taxable account. The logic behind this was that tax rates are low now compared to what they will be.

Any thoughts? Thanks!

But the question is will your taxes in retirement be higher or lower
than while you are working. For 95% the answer is lower, so try
to save taxes now. Ideally you save the max in 401K and have some
left over to put in a taxable account.
TJ

 

[harley]

But the question is will your taxes in retirement be higher or lower
than while you are working. For 95% the answer is lower, so try
to save taxes now. Ideally you save the max in 401K and have some
left over to put in a taxable account.
TJ

I'm not sure if I buy that number, at least for people that are putting significant money in 401Ks. I'm sure there are many that fit your idea, but I think it makes more sense to just capture the match, and put the rest into a Roth. Or if you aren't eligble, do the non-deductible IRA and convert after 2010. That way you have some money in pre-tax, but you aren't faced with large (if you are lucky) RMDs that will knock you into a higher (maybe much higher in the future) tax bracket. And if you never need the money inthe Roth, it's an excellent estate inheritence tool. Plan for the worst, and hope for the best.

 

[jdw_fire]

I'm sure there are many that fit your idea, but I think it makes more sense to just capture the match, and put the rest into a Roth. Or if you aren't eligble, do the non-deductible IRA and convert after 2010. That way you have some money in pre-tax, but you aren't faced with large (if you are lucky) RMDs that will knock you into a higher (maybe much higher in the future) tax bracket. And if you never need the money inthe Roth, it's an excellent estate inheritence tool. Plan for the worst, and hope for the best.

actually if you think you will be in a lower tax bracket after retiring it makes more sense to max out the 401k and then convert some of that to the roth after you retire and are in the lower bracket.

 

[Finance Dave]

Future taxes could easily be spending based, like a VAT or a sales tax, and that would mess up your plans.

Do you really think Congress will change tax laws that fast? I think the OP is on the right track.

 

[JustNtime]

As an early retiree wannabee, it would seem prudent to plan where funding for at least the first 5-10yrs would be specifically coming from and the tax consequences. Then to rinse and repeat as necessary for changing conditions...

My plan was to supplement my pension(as required) with funds from a D-day supply of I-bonds I bought just before and just after early retirement(48) in 2002. Current I-bonds are much less attractive and CD ladders are also underwhelming imho. As a back-up plan I looked at doing SEPP to IRAs or taking out the contributions from my Roth. I suppose if I was looking to retire soon I'd look for some nice stable no-load funds with modest yields to place a few years worth of spending money. Then replenish as appropriate and prudent to market timing...

I was hoping my I-bond supply would take me to 62 where SS would hopefully kick in to supplement my pension. Or at least until 59 when I could start to withdraw IRA money without penalty or SEPP hassle. After 7 yrs - This is still my plan, although I've only cashed a couple I-bonds a couple years ago - It is now difficult to part with my good friends and safety net. Our pension has more than met our spending requirements and annual surpluses are the norm... I recently ran a retirement calculator which indicated we could spend an extra $50k a year and still have a greater than 90% probability of making it to 92. Very reassuring - but the Scotch in me is finding it difficult to abandon a lifetime of 'frugality' and give into the dark side...

 

[harley]

As an early retiree wannabee, it would seem prudent to plan where funding for at least the first 5-10yrs would be specifically coming from and the tax consequences. Then to rinse and repeat as necessary for changing conditions...

My plan was to supplement my pension(as required) with funds from a D-day supply of I-bonds I bought just before and just after early retirement(48) in 2002. Current I-bonds are much less attractive and CD ladders are also underwhelming imho. As a back-up plan I looked at doing SEPP to IRAs or taking out the contributions from my Roth. I suppose if I was looking to retire soon I'd look for some nice stable no-load funds with modest yields to place a few years worth of spending money. Then replenish as appropriate and prudent to market timing...

I was hoping my I-bond supply would take me to 62 where SS would hopefully kick in to supplement my pension. Or at least until 59 when I could start to withdraw IRA money without penalty or SEPP hassle. After 7 yrs - This is still my plan, although I've only cashed a couple I-bonds a couple years ago - It is now difficult to part with my good friends and safety net. Our pension has more than met our spending requirements and annual surpluses are the norm... I recently ran a retirement calculator which indicated we could spend an extra $50k a year and still have a greater than 90% probability of making it to 92. Very reassuring - but the Scotch in me is finding it difficult to abandon a lifetime of 'frugality' and give into the dark side...

That's odd. Many of my visits to the dark side have been the direct result of having a bit to much scotch in me.

 

[walkinwood]

I maxed my 401K right up to the last year. My retirement budget is no where near what I was making when I quit.

Plan on rolling your 401-k funds to an IRA as soon as you ER, so that you can choose low cost investments & have full control of your account.

 

[mathjak107]

i dont buy the higher tax thing either. for decades tax rates are dropping for most of america and every year 3% more income is allowed thru at lower rates

i dont know many people who will be in a higher tax bracket with no pay check then they are with a paycheck... i wont even mention alot of us will retire in lower or no tax states....

35,000 IN INCOME WHEN YOUR RETIRED IS ABOUT 1500 BUCKS IN TAXES, KNOW WHAT THAT SAME 35,0000 WOULD COST ME IN TAXES NOW ON A CONVERSION?

 

[W2R]

I always maxed out my TSP (=401K) and over-50 catchup, and I continue to do so right up until my retirement, two weeks from today.

I wish that more of my nestegg was tax sheltered, so that I would have room for all of my bond allocation there instead of in taxable.

 

[mathjak107]

most people dont even realize there is no advantage in a roth vs traditional gain wise either,.. they assume because the gains are tax free you get more at the end but you dont. assuming the same tax rate they both give you the same amount.

assuming your in the 25% tax rate, 1000 bucks in a deductable ira goes up 100% ..its 2,000 bucks.. you get taxed at the end at 25% and clear 1500 bucks.

you take the same 1,000 bucks from income and put it in a roth, 250 bucks goes for taxes up front , 750 in the roth....

it goes up same 100% , you get 1500 bucks tax free.......

how many americans dont get that concept? quite a few

 

[harley]

You are totally disregarding the RMD and estate aspect of the Roth. Also, if you read the paper that GotADimple linked to in this thread http://www.early-retirement.org/for...heres-a-formula-to-help-you-decide-46992.html (post 4) you'd see that there are different types of potential converters, and different situations where converting may or may not be in your best interest. As to your previous comment about taxes going/staying down, I'd love to believe that. I'd also like to still believe in Santa Claus.

I personally am in the same tax bracket I was in before retirement, and was in a higher one a couple of years ago (while retired). I'm trying to manage my income in a way to minimize my taxes now, partially so I can do some conversions. I don't want to be forced into a large RMD in 17 years, I'd prefer to have a choice even if I don't come out ahead financially. But mostly, I firmly believe tax rates will go up in the near future, and stay up for a long time. Not a political statement, just my interpretation of current economics.

 

[jdw_fire]

most people dont even realize there is no advantage in a roth vs traditional gain wise either,.. they assume because the gains are tax free you get more at the end but you dont. assuming the same tax rate they both give you the same amount.

assuming your in the 25% tax rate, 1000 bucks in a deductable ira goes up 100% ..its 2,000 bucks.. you get taxed at the end at 25% and clear 1500 bucks.

you take the same 1,000 bucks from income and put it in a roth, 250 bucks goes for taxes up front , 750 in the roth....

it goes up same 100% , you get 1500 bucks tax free.......

how many americans dont get that concept? quite a few

o really? how bout this. you have just earned $4000.00 (before taxes) and you want to know whether you should put $3000 into a deductable TIRA or a roth. first 2 assumptions, you are and will be in the 25% tax bracket and you will earn 100% in the TIRA or the roth or in a taxable account.

well if you put $3000 in the TIRA, you have $1000 outside it that you have to pay taxes on leaving $750 in a taxable account. now fast forward to when you have gotten that 100% return and you are gonna pull the money out of the TIRA. the TIRA has grown to $6000 and the taxable account has grown to $1500, but now we have to pay taxes so all of the TIRA is taxable leaving $4500 and half of the $1500 is taxable leaving $1312.50 in the taxable acount totaling $5812.50 after taxes.

but if you put $3000 into a roth you will only have the roth since the rest of the $4000 was paid in taxes. now fast forward and the roth becomes $6000 after taxes.

so they arent the same, there is an advantage to the roth (provided tax rates and investment returns are equal) if you have maxed out your ira contribution for the year and are saving on top of that. there is a similar advantage to doing TIRA to roth conversions if you pay the taxes with money outside the ira

 

[mathjak107]

i think you figured wrong but im not sure.... first question is why did you not figure it with all 4,000 in the ira and 3,000 in the roth which is 4,000 less the 1,000 tax. which is typically how it works out for a 4,000 layout .? i can see the roth winning on any money invested outside the confines of the ira unless you use tax free municipals or very very low distribution index funds or tax managed funds....

if you took 5,000 out of pocket to put 4,000 into a roth and 1,000 in tax then you could put 4000 out of pocket into a traditional and 1,000 which is your tax refund on the ira amount in a tax managed or index fund outside the roth. that 1,000 is your tax refund on the deductable part of your ira so it has no tax yet on it..you paid the taxes intially thru payroll but got that tax money back when you did the ira.i think that extra money growing and having only a 15% capital gains rate would leave you within spitting distance of the roth.


i think the problem in your example is you taxed the 1000 going into the account outside the ira. that shouldnt have been taxed going in and should have been left in its entire amount as its made up of your refund of taxes paid for putting the 4,000 in the ira. ... i may be wrong as its making my hair hurt but if i am point out where so i know

i havent run these numbers to see how close it works out

 

[mathjak107]

My gut feeling is ill be in a lower bracket when i retire, as besides the decades of the brackets allowing more and more thru at lower rate and the fact that im moving from new york city to pa and thats a big drop in state taxes, also no more pay check. there is one other thing i feel

i cant see any political party telling 180 million baby boomers that they are raising their income taxes..... i do see taxes of all kinds popping up and increasing but i dont think income tax increases are in the cards for middle america for our generation.


i always like to plan around what was, what is and what stands a good chance of what will be. i never like to plan around what if's

 

[kaneohe]

MJ107........this is, in fact, a "hair hurting" exercise. I think both of you are right.......in the example you each chose to solve. In your case, you are assuming a limited amount of cash, so that the IRAs end up starting with different amounts. jdw has assumed "unlimited" amounts of cash so that the IRAs end up starting with the SAME (maxed out) amount. In his case, the Roth will win. Note: I probably didn't use the current maxed out amount but that doesn't affect conclusion.

I'm probably saying the same thing as jdw w/ different words:
1) Rothman makes $4K contribution to Roth IRA. He has to pay extra $1K in taxes so his taxable account is $1K smaller than TIRAman.
2) TIRAman makes $4K contribution to TIRA. He pays no taxes on that income. His taxable account is $1K larger than Rothman.
3) Some yrs later, the investments have doubled. Rothman has 8K, all of which is tax free. TIRAman has 8K in TIRA,after tax = 6K. He also has 2K more in aftertax account (before taxes), pays tax on 1K gain=
1.85K after tax. TIRAman has total of 7.85K which is less than the 8K of Rothman. Whether you want to call that "within spitting distance"
or 1.875% less is a semantic issue.

The tricky part is not counting the 1K difference due to the tax twice.

The Roth wins in jdw's case because, when both Roth and TIRA are the same initial size, the Roth is "effectively larger".

 

[mathjak107]

Exactly my point, if you compare you must offset the difference out of pocket by increasing the non roth.... otherwise its not apples to apples

taking 5,000 in income to put 4000 in a roth and invest another 1,000 in pre-paid taxes is not a good comparison to only an investment of 4000 in a traditional or 401k without accounting for the extra money layed out in the roth case

the fact is if its roth vs traditional the net amount is exactly the same at the end . there will be a slight diference in roth vs taxable investment / tradional ira combo giving the edge to a roth.

 

[kaneohe]

MJ107........I think I have not succeeded in my attempt. I'm not sure I understand what you are saying but you cannot increase the TIRA (non roth) over the Roth contribution because there is a maximum annual contribution limit (which probably is different from what I used in my example....but doesn't affect conclusion). You can only account for the difference in an after tax account owned by TIRAman.

 

[mathjak107]

yes i understand that part of it.... but to simplify my point 4,000 in a roth is exactly the same as a 5000 contribution in out of pocket costs to a 401k and assuming same tax bracket, equal returns and costs the returns from both would be identical. the tax free return of the roth is the same as the 401k after taxes.

4000 in a roth plus 1000 in taxes = 5,000 in 401k contribution....

the roth will give you no rmd later on but that may or may not be a factor if your ss will end up being taxed later anyway from other income sources....

the fact we are in new york city , a high tax locality and high tax state plus no pay check when we pull the plug next year on working and move to PA may very well offset the taxes created later on by the rmd by lower taxes in retirement...

my plan is to live off my ira's and 401k money first dwindling down the rmd's long before i get there.

i have lots of numbers to crunch to check all this out.

Its some tough calculations to see whether hitting 401k money first as opposed to having had a roth and letting it alone would be a head or behind from letting the taxable money grow and paying on everything at a lower tax rate later then pre-paying everything with a roth now and most likly a higher tax rate. even if rates stay the same the state and local taxes now are brutal..


grrrrrr my hairs hurting again ha ha ha