As I learn more about investing, my 401k DOESNT look so great....

[thefed]

After looking into it more, I see that my fees are outrageous on the 401k my work offers, thru John Hancock.

The AVERAGE is about a 1.5% expense ratio.

Versus my Vanguard roth at .4 or .3

Over the next 25 years, thats a LOT of money.

I currently contribute 7% of my pre-tax pay to 401k, of which, 1% is matched by employer. My 1 yr return to date is around 9%

I also contribite about 9% of my POST tax pay to a ROTH IRA. It's a VANGUARD account, I just opened it, and thus don't have a 1 year benchmark to go by. I do NOT max the ROTH out.

would it be wise to KEEP some of that 401k money OUT of the 401K and put it in the ROTH, or a REGULAR IRA?

I chose a ROTH because of the flexibility of taking out contributions penalty free for my son's college education. And also, as a safety net in case of financial complications later in life.

Any suggestions? Thanks!

 

[soupcxan]

Do whatever is required to get the full match in your 401k. You're saying your employer only kicks in 1%? How much do you have to contribute to get that?

Better to avoid the high fees and use a Roth or even a taxable account, just make sure you keep tax efficient funds in it (large cap stocks) and use the portion in your 401k/roth for bonds, commodities, and other tax inefficient asset classes so your overall asset allocation is where you want it to be.

 

[Cut-Throat]

Don't forget though, your 401K is Pre-Tax money. The tax deduction alone is generally worth it. A 9% return this year is also pretty damn good! - I've seen a lot worse 401K plans than yours!

I would contribute the max and cut your taxes!

 

[thefed]

lo. 2 answers. 2 ideas. i love it

i must contribute 4% to get their match 1%


What other takes on the situation do you guys have?

 

[wildcat]

See if your employer offers a Roth 401K. I would consider it if you have crappy choices and if you are in a lower tax bracket. If it does offer the Roth 401k you could throw money in there, fund your Roth IRA and possibly invest in your 401k just for the match. If it doesn't then I would just invest in the 401k up to the match, fund your Roth IRA and invest in low exp index funds in a tax account. Your current tax situation should influence your decision but giving that you are 22 I doubt you are in a high tax bracket. Sounds like a lot but exp ratios are a very important issue to consider.

 

[thefed]

See if your employer offers a Roth 401K. I would consider it if you have crappy choices and if you are in a lower tax bracket. If it does offer the Roth 401k you could throw money in there, fund your Roth IRA and possibly invest in your 401k just for the match. If it doesn't then I would just invest in the 401k up to the match, fund your Roth IRA and invest in low exp index funds in a tax account. Your current tax situation should influence your decision but giving that you are 22 I doubt you are in a high tax bracket. Sounds like a lot but exp ratios are a very important issue to consider.

why would low cost index funds be best placed in a "tax" account?

Exp ratios ARE very important, and thus I think I want to eliminate all the excess contributions to my lousy 401k.

 

[HFWR]

Low-cost index funds should be tax efficient; i.e. not much turnover, so limited cap gains tax, and divvies taxed at lower rate.

 

[Gone4Good]

Although the 0.25% match up to 4% is pretty lame, it grossly outweighs the higher fund expenses.  For example, if you make $30K and contribute $300 (1%) your employer will kick in an additional $75 - a 25% return on your contribution!!  So definitely fund your 401(k) up to the 4% level.  

Some considerations for contributions above the 4% level:

1) The 401(k) is a better plan if you expect your tax rate in retirement to be LOWER than it is now.  If you are currently in a high tax bracket this fact may outweigh the expenses saved by switching to Vanguard.

2) Conversely, the 401(k) is a worse plan than the Roth if you are in a low tax bracket (particularly if you think taxes can only go up from here to finance everyone else's retirement).

3) Income / contribution limits.  You are currently contributing approximately 16% of your income to tax advantaged vehicles.  If you move some away from the 401(k) you may run into contribution limits preventing you from saving as much as you are currently - so check the limits first.

My guess is that you will probably be best served by contributing to your 401(k) up to 4% and then moving everything else over to the Roth.  

 

[Cut-Throat]

My guess is that you will probably be best served by contributing to your 401(k) up to 4% and then moving everything else over to the Roth.

Yrs,

Why would you want to give up a Tax Deduction now when your earning loads of money, for a chance not to pay taxes on the earnings in the distant future?

 

[Gone4Good]

Yrs,

Why would you want to give up a Tax Deduction now when your earning loads of money, for a chance not to pay taxes on the earnings in the distant future?

If you assume that your tax rate stays the same (lets say 20%) then you should be indifferent between the 401(k) and the Roth. Example. If you invest $10,000 every year in a 401(k) that earns 8% / year, in 30 years you will accumulate $1.1 MM before taxes or $906,266 after taxes. If you instead take $8,000 after tax dollars and invest it in a Roth at 8%, in 30 years you will have accumulated $906,266 after tax.

For people in low tax brackets, the Roth is a better choice unless you think that some how taxes will be lower in the future.

 

[MasterBlaster]

Why would you want to give up a Tax Deduction now when your earning loads of money, for a chance not to pay taxes on the earnings in the distant future?

Well, As the previous poster demonstrates, if tax policy remains constant, Paying taxes now in a ROTH IRA, or paying taxes later in a traditional IRA is a wash in after tax income. This , of course, needs to be nuanced using your present and future tax bracket. If you'll be in a low(er) tax bracket when you pull the money out of the traditional 401k/IRA then clearly that is the preferred route. If the reverse is true then the Roth may be the way to go.

some people believe however that with the whopper government obligations to the Boomers that tax rates are destined to go up quite a bit. Better to pay a little now than alot later. So just maybe a ROTH is the best choice.

I am somewhat bothered though, by putting alot of money into a ROTH and trusting that congress will or will not change the rules. That's quite a leap of faith.

If only we knew what tax policy would be for the next 50 years then we could suggest an optimal investment strategy.

 

[Cut-Throat]

Well, I'm going to take the opposite argument now. Isn't all the gains from the Roth Tax free as well? And the gains from the 401K are All taxed at withdrawal?

I never really studied the Roth too much when I was working, because I always made to much money to qualify.

And then there is the other saying. "Always defer taxes, you may never have to pay them"

 

[Gone4Good]

Well, I'm going to take the opposite argument now. Isn't all the gains from the Roth Tax free as well? And the gains from the 401K are All taxed at withdrawal?

I never really studied the Roth too much when I was working, because I always made to much money to qualify.

And then there is the other saying. "Always defer taxes, you may never have to pay them"

Yes, 100% of 401(k) withdrawals are taxed as ordinary income (no benefit for capital gains, dividends, etc.). And yes, 100% of Roth withdrawals are tax free. The difference between the two is really an arbitrage between current and future tax rates. Because we don't know what future tax rates will be, it may make sense to 'diversify' by investing in both if you're in the middle tax brackets. If you're in the highest brackets it seems like a no brainer to take the current deduction now. Similarly, if you're in the 10-15% bracket, probably best to pay the freight now and accumulate tax free savings for the future.

This raises another point for people to consider when calculating their net worth. 401(k) balances are pre-tax balances. $1 MM in a 401(k) is not worth the same as $1MM in a Roth or taxable account.

 

[thefed]

nice conversation here, i like it

anything related to the original post is very welcome.

i am torn between ROTH, IRA, and 401k...im in a low bracket now tho, and should be for a while (i deduct heloc,mortgage interest,dependant,head of household etc etc)

SO, most is going toward a roth now. I may reduce my 401k conbtribution the next time they let me.

Is the 4k limit on an IRa for a ROTH and traditional COMBINED, or can you do 4k each?

 

[LOL!]

If you assume that your tax rate stays the same (lets say 20%) then you should be indifferent between the 401(k) and the Roth.  Example.  If you invest $10,000 every year in a 401(k) that earns 8% / year, in 30 years you will accumulate $1.1 MM before taxes or $906,266 after taxes.  If you instead take $8,000 after tax dollars and invest it in a Roth at 8%, in 30 years you will have accumulated $906,266 after tax. 

For people in low tax brackets, the Roth is a better choice unless you think that some how taxes will be lower in the future. 

Don't forget that in the future when one begins withdrawing from the 401(k) that one will very likely be in a lower tax bracket. The first $16K or so of earnings are tax-free (that is 0% tax-bracket) for a couple. You also don't need to withdraw as much to cover a certain standard of living because you won't need to pay social security or medicare taxes. You won't need to earn money in retirement to put into your 401(k), etc.

So the fact is that money going into a 401(k) saves you taxes at your marginal tax rate, while money withdrawn in retirement will be taxed at a lower bracket or lower average tax rate.

Therefore, the 401(k) wins hands-down ... unless tax rates are raised. But given equal rates, the outcome is not equal.

 

[thefed]

Don't forget that in the future when one begins withdrawing from the 401(k) that one will very likely be in a lower tax bracket.  The first $16K or so of earnings are tax-free (that is 0% tax-bracket) for a couple.   You also don't need to withdraw as much to cover a certain standard of living because you won't need to pay social security or medicare taxes.  You won't need to earn money in retirement to put into your 401(k), etc.

So the fact is that money going into a 401(k) saves you taxes at your marginal tax rate, while money withdrawn in retirement will be taxed at a lower bracket or lower average tax rate.

Therefore, the 401(k) wins hands-down ... unless tax rates are raised.  But given equal rates, the outcome is not equal.

but what about a 401k that has 1.5 expense ratio funds...lol

 

[LOL!]

Is the 4k limit on an IRa for a ROTH and traditional COMBINED, or can you do 4k each?

COMBINED, not each.

but what about a 401k that has 1.5 expense ratio funds...lol

While 1.5% expense ratio looks bad compared to Vanguard funds, it is not so awful compared to run-of-the-mill funds.

As written previously, it all depends on your tax bracket.  The Roth IRA has some other advantages besides just tax-free upon withdrawal.  So while you are in a low marginal bracket (what is your marginal tax rate?, what is your overall rate?)  it may make sense to do the Roth.

Best bet: Max out both your 401(k) and your Roth IRA.

 

[thefed]

COMBINED, not each.

While 1.5% expense ratio looks bad compared to Vanguard funds, it is not so awful compared to run-of-the-mill funds.

As written previously, it all depends on your tax bracket. The Roth IRA has some other advantages besides just tax-free upon withdrawal. So while you are in a low marginal bracket (what is your marginal tax rate?, what is your overall rate?) it may make sense to do the Roth.

Best bet: Max out both your 401(k) and your Roth IRA.

i will gross about 34k, but i have about 18k taxable income

 

[Dawg52]

It's funny you mentioned John Hancock funds. Our company uses them and we are in the process of looking at some different companies. JH is an insurance based product that also includes some "wrap" fees that are netted out of the plan value which reduces each individuals portfolio value. They are usually about 3/4 to 1% of the plan value. These are on top of the fund expenses that are shown in the literature that employees receive.

We are looking at a plan with Fidelity that actually has a little higher admin fee for the company, but eliminates the wrap fee plus has lower fees for each fund. The only downside, not as many fund choices as with JH.

You might ask your 401k administrator if there are any wrap fees that are on top of the 1.5% you mentioned. It's possible your company might be absorbing them where as our company passes them on to the individual.  

 

[Martha]

Is the 4k limit on an IRa for a ROTH and traditional COMBINED, or can you do 4k each?

The limit is the combined limit. For most all you would want to know about IRAs can be found in this IRS publication: http://www.irs.gov/publications/p590/

My gut feeling is to get up to the 401(k) match first, then max out the Roth, and if you have any further ability to save, go back to the 401(k) to max that out.

 

[lazyday]

The AVERAGE is about a 1.5% expense ratio.

1. What is the lowest E/R? (for a fund you'd like to invest in, in your 401k)
2. How long do you expect before you retire?
3. How much longer do you expect to work at this company?
4. Do DOG's wrap fees apply?


1. Maybe your plan has an index fund, with "only" about .5% fees?

2. For example, it might make sense to slowly convert 401K to ROTH after retiring, at a very low tax bracket. Another consideration is having some money in each type (taxable,roth,tax deferred) for flexibility.

3. To compare benefit of company 1% matching to # of years of high E/R. If you quit, can roll over 401K to your own account, like at Vanguard.

 

[cj]

Martha said:

"My gut feeling is to get up to the 401(k) match first, then max out the Roth, and if you have any further ability to save, go back to the 401(k) to max that out."

That seems to be the conventional wisdom from many sources I know and respect.  Don't ever leave matching money on the table!  But then, take advantage of the Roth.  The younger you are, the more this makes sense (to accrue compounding returns in an account that will never be taxed). 

A lot of people do say to max out the 401K first to get the big tax break now, because "when you are older and take money out of your 401K you will be in a lower tax bracket".  I am not at all convinced this is true.  I say, after the 401K match, max out your Roth, and then go from there.  If you can max out both the Roth and the 401K, even better!

CJ

 

[thefed]

1. What is the lowest E/R? (for a fund you'd like to invest in, in your 401k) = 1.4
2. How long do you expect before you retire? 23 YRS,SEMI
3. How much longer do you expect to work at this company?10 YRS?
4. Do DOG's wrap fees apply?NO

 

[MasterBlaster]

I say, after the 401K match, max out your Roth, and then go from there.  If you can max out both the Roth and the 401K, even better!

Along these lines other people think

1) pay into the 401k enough to get all of the match
2) max out the Roth
3) put any extra funds in an after tax, low turnover, low expense ratio index fund.

gains in the after tax account when you take it out will be taxed at (lower) capital gains rates rather than (higher) ordinary income tax rates of a 401K. Between better tax treatment and the low expense ratio of the after tax index fund versus much higher expense ratios and hidden (wrap) fees in the 401K you probably will end up with significantly more real after tax income with this strategy.

 

[thefed]

Along these lines other people think

1) pay into the 401k enough to get all of the match
2) max out the Roth
3) put any extra funds in an after tax, low turnover, low expense ratio index fund.

gains in the after tax account when you take it out will be taxed at (lower) capital gains rates rather than (higher) ordinary income tax rates of a 401K. Between better tax treatment and the low expense ratio of the after tax index fund versus much higher expense ratios and hidden (wrap) fees in the 401K you probably will end up with significantly more real after tax income with this strategy.

how much are capital gains? 15%?