Author Topic: Max out 401K or save more for house down payment?  (Read 25995 times)

Sekk

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Max out 401K or save more for house down payment?
« on: November 15, 2012, 10:20:10 PM »
Background:

I'm in my mid 20's.
Full time job.
Paying 6% into my Roth 401K which maxes out my employer contribution of 3% on top of that.

So here's my conundrum:

I'd like to save up enough money to have a 20% down payment on a house, get a used car (my current one won't likely last another year), and have an emergency fund available by 2015 while interest rates are still likely to be rock bottom.  Given that the Fed's current plan is to keep interest rates at rock bottom up until at least the middle of 2015, I am treating that as a hard deadline to get a mortgage before interest rates spike.

So I tallied up a budget using very conservative estimates.  No spike in salary and assuming costs will always be on the higher end for anything that is currently unknown in the future.  After tallying up the numbers, I don't see how I can go about accomplishing the above stated goals and pay more into my Roth 401K than I currently am.

And by 2015, I will not have met the 5 year rule for any of my money in my 401K to qualify for a rollover into a Roth IRA.  Because of that, taking a "first time" homebuyer's loan from my retirement account is not an option.



Is there something glaring I am missing here?  Why is it that left and right, I see people saying that one should max out their 401K contributions without any (visible) consideration of when interest rates may rise?

COguy

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Re: Max out 401K or save more for house down payment?
« Reply #1 on: November 16, 2012, 03:43:04 PM »
Hey Sekk,
  What tax bracket are you in, no need to share profession or salary or anything, but it is kind of needed for looking at the whole picture here?  Of course if you don't share it, we can still break things down.

It sounds like I am a lot like you.  I am in my mid 20s and thinking someday I might buy a house.  There are many opinions on here, but I will write about how I approach the situation, so feel free to disagree with me. 

I am in the 25% bracket, so I max out my Roth IRA (maybe not so wise due to my 25% bracket) and max out my 401K each year.  Then I throw the rest into low turnover passive stuff in a taxable account and some i-bonds (where I currently have about a 10% down payment for the average house in my area stored).

I used to be in a serious rush to buy a house.  But, I am not now.  The area live in is probably a great place to buy.  Heck MMM lives in the same town and has said so himself.  I am a handy guy and can handle almost all of the repairs myself.  But, I am in no rush...

The bulk of this comes from not being sure if I will stay in one place for 5+ years.  I don't think this is likely, but talk to me in 5 years.  It very well could happen.

So, let's say you are willing to stay for 5 years after you have the down payment saved up.  Are you sure the Fed will raise rates in 2015?  They could go up earlier or much later.  The rates in Japan have been  near zero for years.  So, we don't really know there and I wouldn't be super sure about what they say.

If I were you, I would keep your 401k the way it is today (6%) and max out a Roth IRA (you can take the contributions out at any time and hence use them towards a house down payment).  Then save whatever is left towards your down payment in some other account that you can access at any time.  If you really feel you want a house that bad then saving up that down payment like crazy is the way to go.  In no time I bet you will have that down payment sitting in the bank and then you can max out your 401k contributions.

 Is this the optimal scenario for maximizing lifetime earnings on your money?  Probably not, but life is about being happy, not dying with the biggest bank account.  So if owning a house soon is truly a goal of yours, then go for it and save a ton and don't worry so much about 401k contributions for now.

Always keep in mind that if rates do indeed go up, you can always take everything into your own hands and put every dollar you have towards paying down that mortgage with a 27% interest rate:)  It is not ideal, but a big part of the mustachian philosophy is learning to detach yourself from externalizes like interest rates and live in whatever world is thrown at you. 

And if that is still not good enough and you miss the low interest rate train, I will probably be kicking myself personally for not getting a mortgage at low rates so you can find solace that their are other fools like me out there. If you end up in the same town then we can go get a beer together.

I hope that helps.

« Last Edit: November 16, 2012, 03:47:22 PM by COguy »

Sekk

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Re: Max out 401K or save more for house down payment?
« Reply #2 on: November 16, 2012, 07:17:35 PM »
Hi COguy,

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What tax bracket are you in

I am in the 25% tax bracket and I currently have all my 401K money going into a Roth 401K.

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So, let's say you are willing to stay for 5 years after you have the down payment saved up.  Are you sure the Fed will raise rates in 2015?

Of course I don't know the Fed will raise rates in 2015.  But in lieu of alternative guidance, I am acting on the Fed's last definitive statement.  Barring a new Fed chief in 2014 convincing the board to stop QE infinity, I choose to believe the Federal Reserve is trustworthy enough to at least stick to the "at least until the middle of 2015" statement.  Do you believe this to be an unreasonable course of action to take or is there something else big I'm not considering?

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The bulk of this comes from not being sure if I will stay in one place for 5+ years.  I don't think this is likely, but talk to me in 5 years.  It very well could happen.

I've still more math to understand as far as mortgages are concerned, so I take it there's something I'm not taking into account after reading this statement  Why does it matter if you stay in the same house for 5 years?

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If I were you, I would keep your 401k the way it is today (6%) and max out a Roth IRA (you can take the contributions out at any time and hence use them towards a house down payment).  Then save whatever is left towards your down payment in some other account that you can access at any time.

Isn't there a 5 year rule before being able to withdraw money from a Roth IRA?  And isn't there a lifetime max of $10,000 on the loan you can take from your Roth IRA?

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If you really feel you want a house that bad then saving up that down payment like crazy is the way to go.  In no time I bet you will have that down payment sitting in the bank and then you can max out your 401k contributions.

Oh I'm sure that's feasible.  I've conservatively crunched the numbers and barring major life events, I should be able to save up for a house down payment.  The question is if I am missing out on something big by not putting more into retirement funds.  I never really understood the fascination with maxing out one's retirement savings.  Especially as a mustachian!  If you live on the cheap for so many years of your life, why will you suddenly need a massive influx of retirement money in addition to social security when you hit old age?  Do wasteful spending habits develop along with wrinkles and grey hair?


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Is this the optimal scenario for maximizing lifetime earnings on your money?  Probably not, but life is about being happy, not dying with the biggest bank account.  So if owning a house soon is truly a goal of yours, then go for it and save a ton and don't worry so much about 401k contributions for now.

I want to have a good life with the option of a full or partial retirement before I'm 45.  As far as housing is concerned, I see the rock bottom interest rates as an opportunity that I don't want to let pass up. 


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Always keep in mind that if rates do indeed go up, you can always take everything into your own hands and put every dollar you have towards paying down that mortgage with a 27% interest rate:)  It is not ideal, but a big part of the mustachian philosophy is learning to detach yourself from externalizes like interest rates and live in whatever world is thrown at you. 

I'm fortunate enough to have absolutely no desire to use credit as if it were money.  As for living in a world with whatever is thrown at me - I'm getting there!  You and I are fortunate enough to be so interested in the Mustachian life at such an early age.  Building a solid foundation at this point will lead to a long, wonderful life.

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And if that is still not good enough and you miss the low interest rate train, I will probably be kicking myself personally for not getting a mortgage at low rates so you can find solace that their are other fools like me out there. If you end up in the same town then we can go get a beer together.

Only one way to find out!  Thank you for your advice - gives me more options to consider.

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And if that is still not good enough and you miss the low interest rate train, I will probably be kicking myself personally for not getting a mortgage at low rates so you can find solace that their are other fools like me out there. If you end up in the same town then we can go get a beer together.

Someday maybe!  Possibly via http://www.couchsurfing.org/.
« Last Edit: November 16, 2012, 09:33:39 PM by Sekk »

sheepstache

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Re: Max out 401K or save more for house down payment?
« Reply #3 on: November 16, 2012, 07:29:46 PM »
Generally you can take a 401K loan up to half the value of what's in the account, maybe check that out?  I think you can get a 15-year repayment plan if it's for a first time home buying.  I haven't doublechecked any of this just remembering some stuff I heard about when I took a loan on mine for something else.

markstache

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Re: Max out 401K or save more for house down payment?
« Reply #4 on: November 16, 2012, 07:46:53 PM »
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I've still more math to understand as far as mortgages are concerned, so I take it there's something I'm not taking into account after reading this statement  Why does it matter if you stay in the same house for 5 years?

Transaction costs: realtors, mortgage application costs, government fees, etc. really add up. This logic is more about constantly buying and selling as the costs don't vary with the time of ownership. If you are going to live in two houses over the course of 40 years, it doesn't really matter if live in the first one for one week or 30 years.

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Isn't there a 5 year rule before being able to withdraw money from a Roth IRA?  And isn't there a lifetime max of $10,000 on the loan you can take from your Roth IRA?

_Contributions_ can be withdrawn at any time without penalty..  The advantage of the loan is that you can repay the principal, whereas withdrawing it cannot be replaced.

Sekk

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Re: Max out 401K or save more for house down payment?
« Reply #5 on: November 17, 2012, 07:00:24 PM »
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Generally you can take a 401K loan up to half the value of what's in the account, maybe check that out?  I think you can get a 15-year repayment plan if it's for a first time home buying.  I haven't doublechecked any of this just remembering some stuff I heard about when I took a loan on mine for something else.

I have a very difficult time justifying the 10% early withdrawal penalty for the loan.  Admittedly I've not done the math behind the withdrawal penalty vs. a higher interest rate to determine what kind of interest rate a mortgage would have to increase to in order to make early withdrawal a fiscally smart option.

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Transaction costs: realtors, mortgage application costs, government fees, etc. really add up. This logic is more about constantly buying and selling as the costs don't vary with the time of ownership. If you are going to live in two houses over the course of 40 years, it doesn't really matter if live in the first one for one week or 30 years.

Ahhh, duly noted.  Thank you.

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_Contributions_ can be withdrawn at any time without penalty..  The advantage of the loan is that you can repay the principal, whereas withdrawing it cannot be replaced.

How does that reconcile with http://www.fool.com/money/allaboutiras/allaboutiras12.htm?  It states that the first time homebuyer can only borrow up to $10,000 without penalty.


markstache

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Re: Max out 401K or save more for house down payment?
« Reply #6 on: November 17, 2012, 07:40:58 PM »
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How does that reconcile with http://www.fool.com/money/allaboutiras/allaboutiras12.htm?  It states that the first time homebuyer can only borrow up to $10,000 without penalty.

I think need to define some terms: a distribution is taking money out of the account that might (and probably does) include earnings. A loan is money taken out with the contractual obligation to repay it later. Contributions are wire transfers of money you put into the account. Earnings are the additional value of the account that accrues above the sum of the contributions.

It is my understanding that in a traditional 401k, one can take a loan against the account. The money comes out of the account without penalty. The loan must be repaid in 5 years (or 15 for home purchase). Interest on the loan is paid to the account. There may be fees from your account servicer to originate the loan, but there is no money owed to the IRS if the schedule of the loan is repaid. If you default on the loan, there are serious tax consequences. There are limits on the size of the loan.

On a Roth IRA (and perhaps Roth 401ks -- I'm not as clear), since contributions were post-tax, they can be taken out at any time without tax penalty. But, once out, they cannot go back in and yearly caps remain at 5000 (or whatever the IRS sets them at).

Also with a Roth IRA, for a first time home purchase, a distribution,_earnings_, can also be withdrawn penalty free up to a cap. The article you linked to covers these cases.

There are some other "hardship" situations that also allow removing earnings from both traditional and Roth  accounts, but that's not what we are discussing. Any other disbursement before age 59.5 includes the 10% penalty and perhaps income taxes.

I've been reading up on this lately, so I think have the basics, but it is clearly complicated, and I would be indebted to anyone who could point out errors.

grantmeaname

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Re: Max out 401K or save more for house down payment?
« Reply #7 on: November 18, 2012, 06:22:23 AM »
My favorite summary of the matter is this wikipedia page. You've got most of the details right, I think. The relevant rows for this discussion are "withdrawal of contributions" and "home down payment", but if I'm reading it correctly you've got all the details right.

DreamingofFreedom

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Re: Max out 401K or save more for house down payment?
« Reply #8 on: November 18, 2012, 06:22:47 AM »
I'm also aiming to save up a 20% downpayment by early 2015, with the hope of buying before interest rates rise.  But if I don't have the money in 2015, or if I don't find a house I like in 2015, there are other options.  It seems pretty unlikely that the Fed will raise interest rates by 5% or something crazy in just a month.  And if mortgages do get more expensive again because the economy is recovering, that might make renting more affordable. 

I guess the takeaway for me is that the real estate market is cyclical.  I too would like to buy at the bottom point of this cycle, but if I miss it, then there will be another cycle pretty soon.  So I would think long-term about whether you really need the 401k money for your retirement goals, and then make the down payment your second priority.

sheepstache

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Re: Max out 401K or save more for house down payment?
« Reply #9 on: November 18, 2012, 08:35:06 AM »
Quote
Generally you can take a 401K loan up to half the value of what's in the account, maybe check that out?  I think you can get a 15-year repayment plan if it's for a first time home buying.  I haven't doublechecked any of this just remembering some stuff I heard about when I took a loan on mine for something else.

I have a very difficult time justifying the 10% early withdrawal penalty for the loan.  Admittedly I've not done the math behind the withdrawal penalty vs. a higher interest rate to determine what kind of interest rate a mortgage would have to increase to in order to make early withdrawal a fiscally smart option.



Markstache said it already, but again, you don't pay a 10% penalty for early withdrawal on a loan.  Because it's not a withdrawal.  In effect the money stays in your account but the company loans you money with the value of the account in collateral. 

COguy

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Re: Max out 401K or save more for house down payment?
« Reply #10 on: November 18, 2012, 10:05:26 AM »
It seems like everyone hit the right points about the Roth and such.  I thought I might mention that in the 25% bracket, I max out my traditional 401k and my Roth IRA.  I plan on having a paid off house and low expenses in early retirement, so I will likely not have that much taxable income in retirement (current 15% bracket and below).  Unless they start to tax the poor more than the rich which I think is unlikely. MMM has an article about low taxes in retirement:

http://www.mrmoneymustache.com/2012/06/04/the-lovely-low-taxes-of-early-retirement/

obviously, I don't know your situation.  But, the Roth accounts are touted around by the traditional retirement folks as the absolute best way.  This may not be the case for you.  I like to diversify my tax treatment.

As far as houses.   I thought about this after your responses to my original reply. I am currently helping my brother fix up a total dump and I can say seeing what he is going through, there is a ton more to home ownership than just the numbers on the paper.  Some upsides and some downsides.  Do you enjoy maintenance?  I love it, so some see this as a downside and I would see it as an upside. But, I also love that I can leave my apartment and forget about it for weeks and months on end.  All of my possessions could be replaced for less than $2000 so I have no worry on that end and I like that.  There are other factors of course.  Things have a way of working themselves out for those who prepare and have a positive attitude.

Sekk

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Re: Max out 401K or save more for house down payment?
« Reply #11 on: November 20, 2012, 07:05:19 PM »
It seems like everyone hit the right points about the Roth and such.  I thought I might mention that in the 25% bracket, I max out my traditional 401k and my Roth IRA.  I plan on having a paid off house and low expenses in early retirement, so I will likely not have that much taxable income in retirement (current 15% bracket and below).  Unless they start to tax the poor more than the rich which I think is unlikely. MMM has an article about low taxes in retirement:

http://www.mrmoneymustache.com/2012/06/04/the-lovely-low-taxes-of-early-retirement

obviously, I don't know your situation.  But, the Roth accounts are touted around by the traditional retirement folks as the absolute best way.  This may not be the case for you.  I like to diversify my tax treatment.

Roth is supposedly old-person money along with other retirement accounts.  I don't really understand the logic of having a substantial balance of old-person money if someone has already found the means to comfortably retire without it.  Of course a bit of extra money for security for extra costs as you age is nice to have, but I'm hard pressed to believe I need to store an excessive amount in retirement funds.  As I sarcastically asked earlier - do wasteful spending habits come with old age?  Am I missing something glaring here?

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As far as houses.   I thought about this after your responses to my original reply. I am currently helping my brother fix up a total dump and I can say seeing what he is going through, there is a ton more to home ownership than just the numbers on the paper.  Some upsides and some downsides.  Do you enjoy maintenance?  I love it, so some see this as a downside and I would see it as an upside. But, I also love that I can leave my apartment and forget about it for weeks and months on end.  All of my possessions could be replaced for less than $2000 so I have no worry on that end and I like that.  There are other factors of course.  Things have a way of working themselves out for those who prepare and have a positive attitude.

Eh.....I honestly don't know how I would react with my own house.  I behave very differently when I feel something is my responsibility or something I earned versus something that I've been given.  I'd hesitantly say that I'm not much of one for constant maintenance, but if I knew what all the routine checks are that I needed to make to prevent a big issue from developing, I'd be more than happy to take care of them all.

COguy

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Re: Max out 401K or save more for house down payment?
« Reply #12 on: November 20, 2012, 09:05:28 PM »
It seems like everyone hit the right points about the Roth and such.  I thought I might mention that in the 25% bracket, I max out my traditional 401k and my Roth IRA.  I plan on having a paid off house and low expenses in early retirement, so I will likely not have that much taxable income in retirement (current 15% bracket and below).  Unless they start to tax the poor more than the rich which I think is unlikely. MMM has an article about low taxes in retirement:

http://www.mrmoneymustache.com/2012/06/04/the-lovely-low-taxes-of-early-retirement

obviously, I don't know your situation.  But, the Roth accounts are touted around by the traditional retirement folks as the absolute best way.  This may not be the case for you.  I like to diversify my tax treatment.

Roth is supposedly old-person money along with other retirement accounts.  I don't really understand the logic of having a substantial balance of old-person money if someone has already found the means to comfortably retire without it.  Of course a bit of extra money for security for extra costs as you age is nice to have, but I'm hard pressed to believe I need to store an excessive amount in retirement funds.  As I sarcastically asked earlier - do wasteful spending habits come with old age?  Am I missing something glaring here?

What I am getting at here is that you can pay 25%+state tax on your money today and put it in a Roth or taxable account.  Or, you can pay no taxes now by putting it in a traditional 401k.  Simultaneously, you fill your Roth IRA and taxable accounts with 5+ years of expenses and get a paid off house (or not).  In retirement, you will most likely spending very little if your house is paid off (or not) which will put you in a lower bracket than today with some breathing room to do rollovers.  You then use this fact to your advantage to roll your 401k money into a Roth account and let it sit for 5 years and you can draw on the contributions from that rollover at will or just let them grow. 

Work through it with your own numbers as far as what you expect expenses to be.  When using this method, there is no "old-person" money.  There is only money in different tax treatment buckets and it usually yields the optimal solution to the early retirement problem unless you are currently in the current 10/15% brackets.  Of course, there is extra work during the withdrawal phase.  But, the tax savings can really add up. 

Personally, the above method pulls in my FI date by over a year if I max out my 401k each year assuming 4% real return on the money using current differences in tax brackets as a guide (basically I assume I will pay 10% less tax on my rollover).  Of course taxes can go up, but I get to choose when to execute rollovers and the way I am saving I could hold out for quite a while...like decades if need be with serious frugality if needed.

I don't know if I made that confusing, but I may have. MMM talks about it here:

http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/

Sekk

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Re: Max out 401K or save more for house down payment?
« Reply #13 on: November 21, 2012, 05:59:13 AM »

What I am getting at here is that you can pay 25%+state tax on your money today and put it in a Roth or taxable account.  Or, you can pay no taxes now by putting it in a traditional 401k.  Simultaneously, you fill your Roth IRA and taxable accounts with 5+ years of expenses and get a paid off house (or not).  In retirement, you will most likely spending very little if your house is paid off (or not) which will put you in a lower bracket than today with some breathing room to do rollovers.  You then use this fact to your advantage to roll your 401k money into a Roth account and let it sit for 5 years and you can draw on the contributions from that rollover at will or just let them grow. 

Work through it with your own numbers as far as what you expect expenses to be.  When using this method, there is no "old-person" money.  There is only money in different tax treatment buckets and it usually yields the optimal solution to the early retirement problem unless you are currently in the current 10/15% brackets.  Of course, there is extra work during the withdrawal phase.  But, the tax savings can really add up. 

Personally, the above method pulls in my FI date by over a year if I max out my 401k each year assuming 4% real return on the money using current differences in tax brackets as a guide (basically I assume I will pay 10% less tax on my rollover).  Of course taxes can go up, but I get to choose when to execute rollovers and the way I am saving I could hold out for quite a while...like decades if need be with serious frugality if needed.

I don't know if I made that confusing, but I may have. MMM talks about it here:

http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/

I am confused somewhat.  You're speaking of the Roth IRA as if you could withdraw the balance presumably without any penalty before the age of 59 and a half.

Additionally, I am confused about the Roth IRA's provision about being able to withdraw contributions at any time.  How does the IRS know what color the money is you're withdrawing?  Can you withdraw any amount up to the exact $ of your contribution without penalty and only incur the 10% penalty on funds (entirely accrued via stock market gains) beyond that?

sherr

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Re: Max out 401K or save more for house down payment?
« Reply #14 on: November 21, 2012, 06:53:41 AM »

What I am getting at here is that you can pay 25%+state tax on your money today and put it in a Roth or taxable account.  Or, you can pay no taxes now by putting it in a traditional 401k.  Simultaneously, you fill your Roth IRA and taxable accounts with 5+ years of expenses and get a paid off house (or not).  In retirement, you will most likely spending very little if your house is paid off (or not) which will put you in a lower bracket than today with some breathing room to do rollovers.  You then use this fact to your advantage to roll your 401k money into a Roth account and let it sit for 5 years and you can draw on the contributions from that rollover at will or just let them grow. 

Work through it with your own numbers as far as what you expect expenses to be.  When using this method, there is no "old-person" money.  There is only money in different tax treatment buckets and it usually yields the optimal solution to the early retirement problem unless you are currently in the current 10/15% brackets.  Of course, there is extra work during the withdrawal phase.  But, the tax savings can really add up. 

Personally, the above method pulls in my FI date by over a year if I max out my 401k each year assuming 4% real return on the money using current differences in tax brackets as a guide (basically I assume I will pay 10% less tax on my rollover).  Of course taxes can go up, but I get to choose when to execute rollovers and the way I am saving I could hold out for quite a while...like decades if need be with serious frugality if needed.

I don't know if I made that confusing, but I may have. MMM talks about it here:

http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/

I am confused somewhat.  You're speaking of the Roth IRA as if you could withdraw the balance presumably without any penalty before the age of 59 and a half.

Additionally, I am confused about the Roth IRA's provision about being able to withdraw contributions at any time.  How does the IRS know what color the money is you're withdrawing?  Can you withdraw any amount up to the exact $ of your contribution without penalty and only incur the 10% penalty on funds (entirely accrued via stock market gains) beyond that?

I'm not an expert, but I think yes, when you withdraw money from your Roth IRA it's assumed to be from the contribution first (which you can withdraw penalty free at any time). Here is an article that delves into it more deeply: http://www.mymoneyblog.com/can-i-really-withdraw-my-roth-ira-contributions-at-any-time-without-tax-or-penalty.html

However I am also confused by COguy's strategy. For most of us every dollar that we put in a Roth IRA has probably already been taxed at 25% + state tax, as he says. But if you know that you're going to be in a lower tax bracket when you retire, why would you not just put everything into a Traditional IRA and take Substantially Equal Periodic Payments from it, which also avoids the 10% penalty and leaves you paying a very low average income tax once you retire instead of the guaranteed 25% with the Roth? http://www.bogleheads.org/wiki/SEPP:Substantially_Equal_Periodic_Payments

The only time using a Roth IRA makes sense to me is if you are expecting your average income tax rate when you retire to be higher than your current marginal tax rate, and you'd have to be spending a *lot* of money to make that happen.

COguy

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Re: Max out 401K or save more for house down payment?
« Reply #15 on: November 21, 2012, 09:27:48 AM »
Sorry about the confusion.  Indeed, the true optimal solution would be to put everything in traditional type retirement accounts and then trigger the SEPP.  The biggest downfall for that is that the SEPP pays out so little right now.  That should change, but I it might not if rates stay low for a long time.  If rates do stay low, you can just do Roth rollovers via MMMs Roth Escape Hatch Method(or whatever he calls it), But that requires 5 years of living expenses outside the traditional type retirement accounts which really shouldn't be a big deal.

As for why I use the Roth IRA (note: I do not and will not personally use a Roth 401k.  In my opinion that is an account type best left for people in low tax brackets), I max it out each year as I can pull the contributions out at any time no matter what.  Even the day after I make them.  Since I don't currently own a house, this gives me a sort of springy debt emergency fund when combined with some cash, I can use it if I want to change jobs, travel the world, or whatever I feel like.  It also helps me reach the 5+ years living expenses detailed above. 

I hope that adds clarity. 

grantmeaname

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Re: Max out 401K or save more for house down payment?
« Reply #16 on: November 21, 2012, 03:49:42 PM »
I am confused somewhat.  You're speaking of the Roth IRA as if you could withdraw the balance presumably without any penalty before the age of 59 and a half.
Yuh-huh. That's how that works.

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Additionally, I am confused about the Roth IRA's provision about being able to withdraw contributions at any time.  How does the IRS know what color the money is you're withdrawing?  Can you withdraw any amount up to the exact $ of your contribution without penalty and only incur the 10% penalty on funds (entirely accrued via stock market gains) beyond that?
Roth IRA's have a "contributions-first" principle. You don't get to elect what "color" the money you take out is: when you take money out, it is categorized as basis (contributions and seasoned conversions) up to and until the point at which you've withdrawn an amount equal to your total basis. Any withdrawals after that point are earnings and get penalized.

Sekk

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Re: Max out 401K or save more for house down payment?
« Reply #17 on: November 22, 2012, 02:23:32 PM »
It seems like everyone hit the right points about the Roth and such.  I thought I might mention that in the 25% bracket, I max out my traditional 401k and my Roth IRA.  I plan on having a paid off house and low expenses in early retirement, so I will likely not have that much taxable income in retirement (current 15% bracket and below).  Unless they start to tax the poor more than the rich which I think is unlikely. MMM has an article about low taxes in retirement:

http://www.mrmoneymustache.com/2012/06/04/the-lovely-low-taxes-of-early-retirement

obviously, I don't know your situation.  But, the Roth accounts are touted around by the traditional retirement folks as the absolute best way.  This may not be the case for you.  I like to diversify my tax treatment.

Roth is supposedly old-person money along with other retirement accounts.  I don't really understand the logic of having a substantial balance of old-person money if someone has already found the means to comfortably retire without it.  Of course a bit of extra money for security for extra costs as you age is nice to have, but I'm hard pressed to believe I need to store an excessive amount in retirement funds.  As I sarcastically asked earlier - do wasteful spending habits come with old age?  Am I missing something glaring here?

What I am getting at here is that you can pay 25%+state tax on your money today and put it in a Roth or taxable account.  Or, you can pay no taxes now by putting it in a traditional 401k.  Simultaneously, you fill your Roth IRA and taxable accounts with 5+ years of expenses and get a paid off house (or not).  In retirement, you will most likely spending very little if your house is paid off (or not) which will put you in a lower bracket than today with some breathing room to do rollovers.  You then use this fact to your advantage to roll your 401k money into a Roth account and let it sit for 5 years and you can draw on the contributions from that rollover at will or just let them grow. 

Work through it with your own numbers as far as what you expect expenses to be.  When using this method, there is no "old-person" money.  There is only money in different tax treatment buckets and it usually yields the optimal solution to the early retirement problem unless you are currently in the current 10/15% brackets.  Of course, there is extra work during the withdrawal phase.  But, the tax savings can really add up. 

Personally, the above method pulls in my FI date by over a year if I max out my 401k each year assuming 4% real return on the money using current differences in tax brackets as a guide (basically I assume I will pay 10% less tax on my rollover).  Of course taxes can go up, but I get to choose when to execute rollovers and the way I am saving I could hold out for quite a while...like decades if need be with serious frugality if needed.

I don't know if I made that confusing, but I may have. MMM talks about it here:

http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/

Okay....the big question there is how a rollover is taxed.  When you rollover the money, is it considered a form of income?  Or is it based off of the tax bracket you have without any consideration at all of how much money is being rolled over for tax purposes?

grantmeaname

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Re: Max out 401K or save more for house down payment?
« Reply #18 on: November 22, 2012, 06:03:51 PM »
If you move money from a Roth 401k or Roth IRA into a Roth IRA, it's a non-tax event. If you move money from a traditional 401k or IRA into a traditional IRA, you got it, it's a non-tax event. It's just if you're going from a traditional account to a Roth account that you're taxed, and then you're taxed on every dollar converted as if it was income. So if you make $80k after tax and convert $20k, you'll have $100k of income to report at the end of the year. (One more caveat: employers can't contribute their match to a Roth 401k account and contribute their Roth employees' matching contribution into a traditional 401k instead, so if you've got $10k of contributions and $3k of match, that $3k is actually in a traditional 401k account.)

Sekk

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Re: Max out 401K or save more for house down payment?
« Reply #19 on: November 22, 2012, 06:44:59 PM »
If you move money from a Roth 401k or Roth IRA into a Roth IRA, it's a non-tax event. If you move money from a traditional 401k or IRA into a traditional IRA, you got it, it's a non-tax event. It's just if you're going from a traditional account to a Roth account that you're taxed, and then you're taxed on every dollar converted as if it was income. So if you make $80k after tax and convert $20k, you'll have $100k of income to report at the end of the year. (One more caveat: employers can't contribute their match to a Roth 401k account and contribute their Roth employees' matching contribution into a traditional 401k instead, so if you've got $10k of contributions and $3k of match, that $3k is actually in a traditional 401k account.)

That would imply COguy's strategy is limited to converting enough income in a given year to get right below the next tax bracket, assuming he's in a low one as it is.  Not as flexible a strategy as was implied.

grantmeaname

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Re: Max out 401K or save more for house down payment?
« Reply #20 on: November 23, 2012, 05:49:01 PM »
Why does it imply that? I'm not following.

Sekk

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Re: Max out 401K or save more for house down payment?
« Reply #21 on: November 24, 2012, 11:54:54 AM »
Why does it imply that? I'm not following.

Here:

Quote
What I am getting at here is that you can pay 25%+state tax on your money today and put it in a Roth or taxable account.  Or, you can pay no taxes now by putting it in a traditional 401k.  Simultaneously, you fill your Roth IRA and taxable accounts with 5+ years of expenses and get a paid off house (or not).  In retirement, you will most likely spending very little if your house is paid off (or not) which will put you in a lower bracket than today with some breathing room to do rollovers.  You then use this fact to your advantage to roll your 401k money into a Roth account and let it sit for 5 years and you can draw on the contributions from that rollover at will or just let them grow. 

Work through it with your own numbers as far as what you expect expenses to be.  When using this method, there is no "old-person" money.  There is only money in different tax treatment buckets and it usually yields the optimal solution to the early retirement problem unless you are currently in the current 10/15% brackets.  Of course, there is extra work during the withdrawal phase.  But, the tax savings can really add up.

In all fairness, I had misread what he had stated.  After re-reading it, there was nothing to be deceived by.  With a paid off house, it would be relatively simple to roll over all the taxable-account money into a Roth IRA when you're in a lower tax bracket within a reasonable amount of time.  So no more confusion there!

It does make a good case for moving somewhere with a low cost of living.