Fund Tax Deferred Accounts on Jan 2

[TromboneAl]

I've always DCA'd into IRAs and other tax deferred/exempt accounts throughout the tax year. But I realize that it would be much smarter to fund them all on Jan 2, and get a full year of tax-deferred/free growth.

Any problem with that?

 

[Martha]

Nope.

 

[Nords]

I asked on Ed Slott's board if I could make a $4000 IRA donation before my spouse had actually had the $4000 worth of paychecks deposited in her checking account.

The CPA's consensus was "no problem."

A few months later (but luckily after earning enough to make the limits) my spouse lost her job.  Problem solved.

I'm starting a different IRA account at Vanguard and they charge a fee for account balances less than $5000.  So next January I'm going to deposit the $4000 2005 contribution, and follow it up a couple days later with the $4000 2006 contribution.  Luckily I'll have the rest of 2006 to straighten THAT out...

 

[maddythebeagle]

"Any problem with that?"

- I think Suze Orman said the same thing during one of her pbs pledgeathons :....I can't remember how much better you do but she said that it helped to fund as early in the year as possible. She also said that you should get long term care insurance and buy a brand NEW GM vehicle, so I dont know how much faith I have in poor Suze, but sounds reasonable. I do it.

 

[Nords]

... but she said that it helped to fund as early in the year as possible.

Well, sure, the idea is that you're maximizing the time for the market to go up and give you as much tax-deferred gains as possible.

So like Will Rogers says, if the market isn't going to go up that year then don't make your IRA contribution on 2 January.

 

[LOL!]

Of course there's a problem with that. 

If these are accounts that hold stocks and the stock market goes down, then you will have done worse than if you had invested later when stocks were lower. 

Conversely, if you can contribute the max allowed amount on a day when stocks are below the value at the beginning of January, then you will have beat the market for the year

But if stocks go up monotonically from the beginning of the year, then you are better off contributing right at the beginning. This also applies if you are invested in CDs and fixed rate investments.

 

[maddythebeagle]

If these are accounts that hold stocks and the stock market goes down, then you will have done worse than if you had invested later when stocks were lower. 

but you are only out if you sell and lock in a year's losses. Otherwise, you are missing out on a year's dividends/reinvestment. You could always contribute the money at the start of the year and dollar cost avg. if you are worried.

 

[wildcat]

isaaaa no problem

 

[LOL!]

Here is another problem with some 401(k) plans like my spouse's plan.  Her company matches her contribution up to 3% of her paycheck.  

Suppose she makes $20K in a paycheck and contributes $14K of it to her 401(k) plan in that first January paycheck, then the company only contributes 0.03 * 20K = $600 for the year because she will contributes $0 from subsequent paychecks.

But if she spreads out the $14K over her 24 paychecks in a year, she contributes $583 per paycheck, that's 2.915% a paycheck (below the 3% max allowed for the company contribution), then the company also contributes $583.  Net result: $28,000 of 401(k) contributions instead of $14,600.

Of course, if you're already FIRE'd, you ain't making 401(k) contributions.  But for those not FIRE'd with 401(k) plans ... be careful out there.

 

[justin]

LOL,

Explain that once more. I didn't follow it, but if it works, I'll do the same thing!!

 

[moghopper]

Suppose she makes $20K in a paycheck

As my tax preparer has said, these are good problems to have.

 

[LOL!]

Suppose she makes $2K a paycheck or $48,000 per year. She contributes $1400 of her first 10 paychecks to her 401(k). The company contributes $60 per paycheck (3% of the $2K) or $600 for the 10 paychecks. There are 14 paychecks left in the year from which no contributions are made (and no company match either). The total contributed is $14,600

Suppose she makes $2K a paycheck or $48,000 per year. She contributes $583 of her 24 paychecks to her 401(k). The company contributes $60 per paycheck or $1440 for the 24 paychecks. The total contributed is $15,440. That's $840 more from the company by spreading out her contributions over all her paychecks.

Not all 401(k) plans work like this. But some do.

 

[bosco]

But I realize that it would be much smarter to fund them all on Jan 2, and get a full year of tax-deferred/free growth.

Any problem with that?

1 big problem from my perspcetive. I have to have the cold, hard cash available on Jan 2. Or else use a credit line. Which could easily negate the positive effects of early investment.

 

[Martha]

Not all 401(k) plans work like this. But some do.

How we designed our 401(k)/proft sharing plan at work was to eliminate the idea of a match. Instead, we give a fixed percentage to emplyees no matter what. This percentage is based on a function of age and length of service, from a low of 3% to a high of 14.5%. This turned out to be very motivating to employees and some who had never contributed to the 401(k) before began contributing. We make the contribution in a lump sum at year end.

The selfish reason we did this was to increase the money owners could put into the plan without violating discrimation rules. This design enables us to not only put in our own employee contribution, but a 14.5% "employer" contribution, up to a maximun of $42,000 for 2005.

 

[LOL!]

Yep, the devil is in the details. My company puts in 2% of salary no matter what. A previous placed I worked put in 15% for the executives no matter what and less for others, but Congress changed the laws. I would have thought that a percentage based on age and length of service would have been illegal.

I am not sure how a no-matter-what company contribution motivates folks to contribute any more. Indeed, they should contribute to a Roth IRA first, shouldn't they?

 

[Alan]

Suppose she makes $20k in a single paycheck?

My wife's company used to match only on the month's she made contributions, whereas my company matched every month even after I had max'ed out.  So you need to know the rules of your company's 401(k) matching.

 

[TargaDave]

How we designed our 401(k)/proft sharing plan at work was to eliminate the idea of a match. Instead, we give a fixed percentage to emplyees no matter what. This percentage is based on a function of age and length of service, from a low of 3% to a high of 14.5%. This turned out to be very motivating to employees and some who had never contributed to the 401(k) before began contributing. We make the contribution in a lump sum at year end.

The selfish reason we did this was to increase the money owners could put into the plan without violating discrimation rules. This design enables us to not only put in our own employee contribution, but a 14.5% "employer" contribution, up to a maximun of $42,000 for 2005.

Martha,
How many people at your firm? Who manages the profit share investment and how are distributions controlled? So age and years of service doesn't discriminate even though it's putting far more tax deferred money in the senior partners hands and not the lower age-service employees compared to a 401k or simple IRA? especially if you have a smaller firm with a big age-service gap between senior partners and office staff-junior lawyers. Or am I off base? Who determines the age-service formula?

A 401k requires an employee to contribute to get the company match but a profit share does not, so I don't understand the employee contribution motivation you refer to. OTOH I would understand the senior partners being willing to accept a plan that pays low age-service employees regardless of wether they contribute because it allows the partners to reap a far larger tax deferral than they would get with a traditional 401k. Actually pretty decent for everyone in the firm and a little less for the IRS.

However, it seems like another subconscious reason not for hiring older staff just like higher health care costs. I just see potential discrimination-abuse written all over this stuff in the wrong hands. I'm really not tryin to pick on you, and you readily admitted the selfish reasons.

 

[Mr._johngalt]

Martha,
How many people at your firm? Who manages the profit share investment and how are distributions controlled?   So age and years of service doesn't discriminate even though it's putting far more tax deferred money in the senior partners hands and not the lower age-service employees compared to a 401k or simple IRA?  especially if you have a smaller firm with a big age-service gap between senior partners and office staff-junior lawyers.  Or am I off base?  Who determines the age-service formula? 

A 401k requires an employee to contribute to get the company match but a profit share does not, so I don't understand the employee contribution motivation you refer to.  OTOH I would understand the senior partners being willing to accept a plan that pays low age-service employees regardless of wether they contribute because it allows the partners to reap a far larger tax deferral than they would get with a traditional 401k.  Actually pretty decent for everyone in the firm and a little less for the IRS.

However, it seems like another subconscious reason not for hiring older staff just like higher health care costs.  I just see potential discrimination-abuse written all over this stuff in the wrong hands.  I'm really not tryin to pick on you, and you readily admitted the selfish reasons.

An aside to TargaDave's post re. "age discrimination", which I believe should be totally legal. But, I digress. My brother is 58, unemployed and looking. He left any reference/hints to his age off his resume, anticipating trouble.
So far he is still looking and has been asked "Are you over 50?"
(he looks his age) and "How long do you plan to work?" Yeah, I know....................this is a no-no. Why doesn't he just retire?
He and I were cut from very different cloth.

JG

 

[Mr._johngalt]

And another thing about my brother............ (don't get me wrong - I love the guy). A few years ago he had a tumor on his spine. Thought he might end up paralyzed. For most people that would be a wake-up call. Didn't seem to wake him up at all, but maybe he is 100%
okay with how he spends his life. Looks boring as hell to me, but
if he likes it then I am happy for him.

JG

 

[Martha]

Martha,
How many people at your firm? Who manages the profit share investment and how are distributions controlled? So age and years of service doesn't discriminate even though it's putting far more tax deferred money in the senior partners hands and not the lower age-service employees compared to a 401k or simple IRA? especially if you have a smaller firm with a big age-service gap between senior partners and office staff-junior lawyers. Or am I off base? Who determines the age-service formula?

A 401k requires an employee to contribute to get the company match but a profit share does not, so I don't understand the employee contribution motivation you refer to. OTOH I would understand the senior partners being willing to accept a plan that pays low age-service employees regardless of wether they contribute because it allows the partners to reap a far larger tax deferral than they would get with a traditional 401k. Actually pretty decent for everyone in the firm and a little less for the IRS.

However, it seems like another subconscious reason not for hiring older staff just like higher health care costs. I just see potential discrimination-abuse written all over this stuff in the wrong hands. I'm really not tryin to pick on you, and you readily admitted the selfish reasons.

I'll try to answer some of your questions. Our office has a total of about 70 employees. We put the profit sharing and 401(k) into one pot, so it doesn't look like separate plans to employees. It was unexpected and interesting to see employees that didn't particpate in the 401(k) plan start to participate when they got profit sharing money.

The age plus length of service formula is for staff. Oddly, without violating discrimiation rules we can put owners into a different class and treat them differently. If I recall correctly, all owners under 40 get 10% profit sharing and all owners over 40 get 14.5% profit sharing (up to the $42,000 cap). I can't remember off the top of my head whether we could and did treat associate lawyers different than other staff. If I remember, I'll check when I get back to the office.

Our board determines profit sharing at year end. We have always done the maximum possible. Of course, if we had a down year we could do less.

We do have a few long term staff employees who get the maximum of 14.5%. Our senior staff are so valuable that we look at the higher profit sharing contribution for them as just another way to keep them happy and employed with us.

Since we put the plan in place when I was in managment, I hired for myself a new secretary who was an older woman. I value her experience. Didn't even think about the issue that she will work into a higher profit sharing contribution quicker because she was older. Didn't think about health insurance. Would be highly inappropriate in any event. Instead, I worried about the ability to pay her enough to come.

In any event, we designed the plan to put as much pretax dollars away for owners as possible. As a result, every employee gets a decent profit sharing contribution. But those costs are less than the tax savings to owners.

 

[TargaDave]

I'll try to answer some of your questions. Our office has a total of about 70 employees. We put the profit sharing and 401(k) into one pot, so it doesn't look like separate plans to employees.

Since we put the plan in place when I was in managment, I hired for myself a new secretary who was an older woman. I value her experience. Didn't even think about the issue that she will work into a higher profit sharing contribution quicker because she was older. Didn't think about health insurance. Would be highly inappropriate in any event. Instead, I worried about the ability to pay her enough to come.

In any event, we designed the plan to put as much pretax dollars away for owners as possible. As a result, every employee gets a decent profit sharing contribution. But those costs are less than the tax savings to owners.

I was under the impression that you were not allowed to do a 401k and pre-tax profit share at the same time. I'll have to give my agent a call. We just do a simple IRA with company match right now. I did start looking into a pretax profit share. Doubt my investors will go for it but never hurts to try.

I've got 16 employees in a small hi-tech manufacturing business and while we have never considered age an issue over skills (mostly advanced degree types here) I will assure you that most businesses on the manufacturing side, especially those with low margins, feel the heat big time.

I have to set all pay, health and tax deferred benefits to get great people in and keep them motivated, then pay for capital improvements and inventory, then hope we hustle enough business not only to pay for it all, but grow it all profitably to keep the investors happy. That's all after raising-spending some serious $ just to develop a product. I guess I see it from a slightly different angle than hiring a secratery. BTW two of our newest employees are also our oldest. No regrets whatsoever in spite of the hit to the health premium. Just don't put me in a room alone with the idiot who sets these demographic health benefit formulas.

Anyway I’m glad it works out well for your firm and I'll keep your formulas in mind.