Where to Invest, Tax Deferred or After Tax

[csalvi]

I just finished reading JL Collins' The Simple Path to Wealth, which is what brought me here. I have one investment, my tax deferred 401k. I had been contributing 12%, but after reading Collins' book, I realize I need to drastically increase that. I'm 57, and just started the 401k 12 years ago. It has $135,000 in it.

So my question is, should I invest all I can in that 401k, or should I only invest up to what the company will match, which is 4%. Then put the rest in a separate Roth IRA?

The reason I am hesitant to put it all in the 401k is the RMD, required minimum distribution. I want to withdraw by the 4% rule when I retire, and I'm pretty sure the RMD will force me to withdraw a lot more than 4%.

If I put it all into the 401k, then when I retire move it into a Roth IRA, in one lump sum, that would put me into a higher tax bracket. If I just transfer a portion each year, to avoid a higher tax bracket, it seems like that would affect the rate of return adversely, but I'm not certain of that.

That's why I am here asking for advice.

Thanks for any help.

Chuck

[maizefolk]

If I put it all into the 401k, then when I retire move it into a Roth IRA, in one lump sum, that would put me into a higher tax bracket. If I just transfer a portion each year, to avoid a higher tax bracket, it seems like that would affect the rate of return adversely, but I'm not certain of that.

The bolded bit appears to be the crux of your decision.

However, converting a portion each year shouldn't have any negative effect on your rate of return vs transferring the whole thing as a lump sum, and is much more tax efficient than the lump sum approach.

[Bernard]

Hi Chuck!
Whether Roth or Traditional/401K depends on the income/tax burden you have now, and income/tax you anticipate in retirement. In almost all cases, tax deferred is better.

In most cases, 401Ks carry higher fees than IRAs, especially when focusing on low fee mutual funds/ETFs. Thus, I would only feed your 401K 'til the employer match. Next is the IRA up to the maximum of $7,000 per year, then again the 401K.

Best of luck to you.

[csalvi]

Hi Chuck!
Whether Roth or Traditional/401K depends on the income/tax burden you have now, and income/tax you anticipate in retirement. In almost all cases, tax deferred is better.

In most cases, 401Ks carry higher fees than IRAs, especially when focusing on low fee mutual funds/ETFs. Thus, I would only feed your 401K 'til the employer match. Next is the IRA up to the maximum of $7,000 per year, then again the 401K.

Best of luck to you.

So with a 401k or an IRA I will come out ahead of a Roth IRA, in spite of the RMD? That is the question that puzzles me. If I am forced to take out 10% or 15% in a year by the RMD, well beyond what I would need, that would greatly reduce the rate of return for what is left in the 401k or IRA, according to my understanding. While only taking 4% out of a Roth IRA would leave a greater balance, leading to greater rate of return, again, according to my understanding.

In other words, doesn't having all or most of your money in a 401k or an IRA at retirement make using the 4% rule impossible, because of the RMD?

Anyway, I appreciate the reply.

Chuck

[csalvi]

If I put it all into the 401k, then when I retire move it into a Roth IRA, in one lump sum, that would put me into a higher tax bracket. If I just transfer a portion each year, to avoid a higher tax bracket, it seems like that would affect the rate of return adversely, but I'm not certain of that.

The bolded bit appears to be the crux of your decision.

However, converting a portion each year shouldn't have any negative effect on your rate of return vs transferring the whole thing as a lump sum, and is much more tax efficient than the lump sum approach.

Thank you for the reply.

I should have mentioned I will (probably) be retiring at 70. So, I would have to start taking RMD immediately. Would you say that I would still be better off investing everything - I'm planning to increase from 12% of my income to 45% of my income - into the 401k, rather than most of it into a separate Roth IRA?

As I mentioned in my reply to Bernard, it seems to me that 401k and IRA make it impossible to abide by the 4% rule. If I am transferring it to a Roth IRA after I retire, in portions small enough to avoid a higher tax bracket, what is left in the 401k each year will still face the RMD.

Chuck

[LightStache]

RMDs don't require you to spend money so there's no relationship to the 4% SWR. You can withdrawal from your 401k and roll it into a Roth IRA throughout retirement or stick it in a brokerage account or under the mattress.

When you're 93 years old and your RMDs hit 10% of your remaining account balance, you can spend 4%, pay 2% to the tax man, and keep the remaining 4% if you want. Depending on investment performance, it's possible that withdrawing 10% from your 401k could actually be in line with the 4% since your account balance could shrink from age 70 to age 93 due to withdrawals exceeding investment returns.

If you run the numbers, in typical cases you'll be better off contributing to a traditional 401k and rolling over throughout retirement, when your marginal tax rate is lower. Of course, you may have an atypical case like a 100% pension plan, large inheritance, etc. that could tip the balance to favor Roth contributions.

It kinda sounds like you don't like RMDs. Regardless of your feelings on taxes and tax policy, make sure you're making the best decisions for yourself based on cold hard numbers.

[csalvi]

RMDs don't require you to spend money so there's no relationship to the 4% SWR. You can withdrawal from your 401k and roll it into a Roth IRA throughout retirement or stick it in a brokerage account or under the mattress.

When you're 93 years old and your RMDs hit 10% of your remaining account balance, you can spend 4%, pay 2% to the tax man, and keep the remaining 4% if you want. Depending on investment performance, it's possible that withdrawing 10% from your 401k could actually be in line with the 4% since your account balance could shrink from age 70 to age 93 due to withdrawals exceeding investment returns.

If you run the numbers, in typical cases you'll be better off contributing to a traditional 401k and rolling over throughout retirement, when your marginal tax rate is lower. Of course, you may have an atypical case like a 100% pension plan, large inheritance, etc. that could tip the balance to favor Roth contributions.

It kinda sounds like you don't like RMDs. Regardless of your feelings on taxes and tax policy, make sure you're making the best decisions for yourself based on cold hard numbers.

Thank you for the reply.

Yes, I do not like RMDs. I would rather decide for myself how much to withdraw each year, rather than be told how much to withdraw. However, I know the government has to have its deferred taxes, so it has to be paid.

It looks like that is the best strategy, to reinvest whatever is above the 4% I will use from the yearly RMD, into a Roth IRA.

Thanks to everyone for their advice.

Chuck 

[MDM]

I'm 57, and just started the 401k 12 years ago. It has $135,000 in it.

So my question is, should I invest all I can in that 401k, or should I only invest up to what the company will match, which is 4%. Then put the rest in a separate Roth IRA?

I should have mentioned I will (probably) be retiring at 70.

$135K returning 4%/yr real will grow to $225K in 13 years.  The marginal rate on withdrawals due to additional traditional contributions would be 0% or 10% for many RMD years, if that is your only income.  Assuming your marginal tax saving rate is 22% now, traditional appears preferable.

If you have significant other income (e.g., a large pension) that would change the picture....

[terran]

That is the question that puzzles me. If I am forced to take out 10% or 15% in a year by the RMD, well beyond what I would need, that would greatly reduce the rate of return for what is left in the 401k or IRA, according to my understanding.

Just to things in a bit of perspective, RMDs don't reach 10% of the balance until you're 92 years old. See https://www.irs.gov/pub/irs-tege/uniform_rmd_wksht.pdf