Author Topic: To Max Out or Not to Max Out Your 401(k)  (Read 1080 times)

shanaling

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To Max Out or Not to Max Out Your 401(k)
« on: May 16, 2019, 10:19:21 PM »
I'm conflicted....just read two blog posts from two bloggers I love arguing for opposite viewpoints. What is your stance?

https://www.financialsamurai.com/you-cant-save-too-much-in-your-401k-for-retirement/

https://wealthyaccountant.com/2019/03/31/when-adding-to-your-retirement-plan-is-a-bad-idea/

Taran Wanderer

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Re: To Max Out or Not to Max Out Your 401(k)
« Reply #1 on: May 16, 2019, 10:34:38 PM »
I told DW the other day that we havenít really needed a financial advisor yet, but that we are getting to a point that we are going to need some tax advice. I read article number 2. Turns out I was right.

reeshau

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Re: To Max Out or Not to Max Out Your 401(k)
« Reply #2 on: May 17, 2019, 02:23:11 AM »
I don't see the second as an argument against a 401(k), just a *traditional* 401(k).

"Solution 1
After a certain point (your facts and circumstances will determine that point) it is better to fill your Roth IRA or use the Roth feature of your 401(k)."


Personally, I think nobody knows what the tax structure will be in 40 years.  Look at how it has changed in the last 40.  So my strategy is tax diversification:  I have traditional and Roth retirement investments and a good chunk of taxable investments.  As I approach retirement, I can spend them in the order that optimizes to the then current tax code, rather than putting all my eggs in one basket.

Of course, if you are contributing to a Roth 401(k), your company match will still be traditional pre-tax, so you will naturally get some balance.

seattlecyclone

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Re: To Max Out or Not to Max Out Your 401(k)
« Reply #3 on: May 17, 2019, 12:34:24 PM »
I think maxing out your pre-tax retirement account makes a lot of sense for most folks. I also think that if you get even close to the point where you predict your RMDs might be in the $500,000 range you probably could have retired a while ago.

Boofinator

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Re: To Max Out or Not to Max Out Your 401(k)
« Reply #4 on: May 17, 2019, 01:32:11 PM »
Not a fan of the second article, seems to use fear tactics and fuzzy math to say, "You need an accountant!" Here's my rebuttal:

First off, paying a lot of taxes on your RMD isn't really a problem that should be "shocking" or result in "catastrophic tax issues". You're filthy fucking rich at this point, so paying more in taxes than was optimal in hindsight might be a minor annoyance, but not a problem in the real sense of the word.

To get into the meat and potatoes, you really need to compare financial decisions over the length of time that the decisions diverge. The most glaring example in this article is in the last paragraph of Solution 1, where he states, "The tax deduction today in[sic] minor compared to the future taxes avoided due to the tax-free nature of Roth growth!" But he neglects to tell you that your tax-deduction (if you chose Traditional) would also grow at the same rate, and in fact Roth and Traditional have equivalent final values if the tax brackets at which the contributions/withdrawals are taxed are the same. (To use numbers for this example, let's say you are in the 20% bracket when contributing and will be in the 20% bracket when withdrawing (and let's assume this investment will octuple over the timeframe). Let's say you have $5000 to invest. You could choose Roth, pay $1k in taxes, and then have $32k to pull tax-free in the future, or you could choose Traditional, octuple to $40k, then pay $8k in taxes. Yes, in the latter case you paid 8x as many taxes, but you still ended up with $32k.)

Actually, he makes this same mistake again in Solution 2 (where he recommends investing in taxable), when he says, "This means that dropping money into a 401(k) at work needs matching to offset the future losses from higher taxes and RMD issues." This is hogwash. With a taxable account, you will be paying your current marginal rate now, a dividend drag over the life of the investment, and then long-term capital gains when you pull out. This is extremely unlikely to beat Traditional, and is almost guaranteed not to beat Roth.

As for Solution 3, well sure, if you reach 59 1/2 and are not working, most people with any math sense will consider pulling out some money to minimize overall tax rates. Go Curry Cracker does a really good job discussing tax optimization strategies.

Solution 4 is the FIRE standard: either use 72(t) or Roth ladder to access your retirement accounts before 59 1/2.

Solution 5 must be a joke, because he is recommending his clients donate all of their RMD money rather than pay taxes on some portion of their money. Nothing wrong with donating to charity, but it sure as hell isn't increasing the amount of money going to his clients.

Bottom line, there is a point where tax optimization strategy would have you choose Roth instead of Traditional, but at this point you'd probably be 1) filthy rich (at least in your 401k/IRA), and 2) making relatively lower income (say, in a post-"retirement" job). This doesn't apply to many people, and could be used in the dictionary as an example of "first-world problems".

"These ideas I shared with you today are only a start. They are the framework to build your financial plan. But the details require the masterís touch." With a foundation this shoddy, no thank you.
« Last Edit: May 17, 2019, 02:27:06 PM by Boofinator »

MDM

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Re: To Max Out or Not to Max Out Your 401(k)
« Reply #5 on: May 18, 2019, 06:15:36 PM »
I'm conflicted....just read two blog posts from two bloggers I love arguing for opposite viewpoints. What is your stance?
The second post assumes a high return on investment.  If that assumption proves correct, the article's conclusions are supportable.

Does remind me of the end of the Investment Order post:
Quote
Note the possibility of self-defeating predictions:
a) predict high taxable retirement income > contribute to Roth > get low taxable retirement income
b) predict low taxable retirement income > contribute to traditional > get high taxable retirement income

Also, if you pick traditional and that ends up being wrong it will be because you have "too much money" - not the worst problem.
If you pick Roth and that ends up being wrong it will be because you have "too little money" - that can be a real problem.
Thus using traditional is a "safer" choice.

seattlecyclone

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Re: To Max Out or Not to Max Out Your 401(k)
« Reply #6 on: May 18, 2019, 08:28:39 PM »
I'm conflicted....just read two blog posts from two bloggers I love arguing for opposite viewpoints. What is your stance?
The second post assumes a high return on investment.  If that assumption proves correct, the article's conclusions are supportable.

They're assuming that the investments will double in seven years (nominal) or ten years (inflation-adjusted), which I think matches up pretty well with the stock market's historical growth rate. I don't have too much problem with that growth number. If you have a stock-heavy portfolio this seems like a reasonable enough estimate.

My main beef with their argument is the assumption that a 50-year-old with $2 million in traditional retirement accounts is planning not to touch those funds at all until they turn 70, which would thereby allow the money to double nearly three times before the $500k RMDs kick in. Even discounting the possibility of early retirement you're probably going to withdraw at least a little bit from savings before you turn 70, right?

A secondary quibble I have is then that they use the nominal growth rate to scare folks with big numbers ("exceeds $500k"), when in fact it would probably be more useful to use the inflation adjusted growth rate to assume two doublings rather than three for said 50-year-old. This would put the inflation-adjusted balance at 70 at $8 million rather than ~$15 million. This puts the inflation-adjusted RMD more on the order of $290k instead of over $500k. It's still a pretty big amount of income to have, but for a married couple that's the difference between being in the 24% bracket and the 35% bracket. Since tax brackets adjust upwards every year to account for inflation I think the inflation-adjusted number is more useful for someone looking at current tax brackets as they plan.

Taran Wanderer

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Re: To Max Out or Not to Max Out Your 401(k)
« Reply #7 on: May 18, 2019, 10:36:30 PM »
They're assuming that the investments will double in seven years (nominal) or ten years (inflation-adjusted), which I think matches up pretty well with the stock market's historical growth rate. I don't have too much problem with that growth number. If you have a stock-heavy portfolio this seems like a reasonable enough estimate.

My main beef with their argument is the assumption that a 50-year-old with $2 million in traditional retirement accounts is planning not to touch those funds at all until they turn 70, which would thereby allow the money to double nearly three times before the $500k RMDs kick in. Even discounting the possibility of early retirement you're probably going to withdraw at least a little bit from savings before you turn 70, right?

A secondary quibble I have is then that they use the nominal growth rate to scare folks with big numbers ("exceeds $500k"), when in fact it would probably be more useful to use the inflation adjusted growth rate to assume two doublings rather than three for said 50-year-old. This would put the inflation-adjusted balance at 70 at $8 million rather than ~$15 million. This puts the inflation-adjusted RMD more on the order of $290k instead of over $500k. It's still a pretty big amount of income to have, but for a married couple that's the difference between being in the 24% bracket and the 35% bracket. Since tax brackets adjust upwards every year to account for inflation I think the inflation-adjusted number is more useful for someone looking at current tax brackets as they plan.

It's the thought behind responses like this that makes me really appreciate this forum.

cangelosibrown

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Re: To Max Out or Not to Max Out Your 401(k)
« Reply #8 on: May 19, 2019, 12:43:42 PM »
Traditional makes sense if your tax rate is higher now, Roth makes sense if your rate will be higher in retirement.  That is incontrovertibly true. The only relevant point the second article makes (in between a bunch of misleading nonsense), is that you should think about RMD's when you determine which bucket you fall into.

The worst part about that second article is that they mention "FIRE" at the beginning of it, and then never say anything relevant in the "analysis" or what passes for an analysis.

Given that we're here because we hope to retire early, it's very hard for the numbers to work out for Roth over traditional.

dandarc

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Re: To Max Out or Not to Max Out Your 401(k)
« Reply #9 on: May 19, 2019, 01:33:40 PM »
I think maxing out your pre-tax retirement account makes a lot of sense for most folks. I also think that if you get even close to the point where you predict your RMDs might be in the $500,000 range you probably could have retired a while ago.
Nailed it. If you get to 70 with $15 million in traditional retirement accounts you either worked too long or live an absurd lifestyle. First RMD is only 3.65%.