Author Topic: Dumb Question from Newbie - Why max out 401k?  (Read 4510 times)

lcerrito

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Dumb Question from Newbie - Why max out 401k?
« on: October 03, 2015, 06:36:17 AM »
Hi!
Long time lurker - first time poster... I'm 26 yrs old and at the start of my FIRE journey. I have always been relatively frugal and very against holding any debt. My husband and I have no debt besides our mortgage ($111,000) which we are applying extra principal towards to pay off 10 yrs early. My question is: What is the importance of maxing out my 401k? I understand the tax saving benefits (I would get $692 in my 401k for the net take home difference of $421 per paycheck). But that would leave me very little to apply towards my VFINX.

If in theory I can withdraw 4% from the VFINX for the rest of my post-FIRE life, why would I need a robust 401k to kick in when I turn 60? I'd personally rather retire 10 years earlier and have a moderate sized 401k to supplement my 4% withdrawal. I currently put 8% in my 401k, and 5% in a Roth IRA. Company matches 4% of first 5% in 401k.

marty998

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Re: Dumb Question from Newbie - Why max out 401k?
« Reply #1 on: October 03, 2015, 06:50:38 AM »
Something something tax breaks something mega pipeline something something roth.

Someone else with an understanding of it care to chip in and explain it? (there's a sticky somewhere too?)

FIREby35

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Re: Dumb Question from Newbie - Why max out 401k?
« Reply #2 on: October 03, 2015, 06:56:34 AM »
It's good that you are saving in taxable accounts and paying your mortgage down. So, great start. From here out, it is about investing with the most efficient path so your wealth grows as quickly as possible.

With the 401k the general consensus is that you should max the 401k first. The difference between pre-tax and post-tax money will greatly affect your long term returns. I don't have any links to show you, but look around on Vanguard's website or this forum and you will find something. Max out the 401k to create more wealth than a standard brokerage account by saving on taxes.

I guess you are probably most worried about the liquidity on your money. The general consensus would be that you should still max out the 401k first because the long term difference is still very large. Build up enough liquidity so you are comfortable but then start getting yourself into the 401k.

Lastly, if you have any sort of company match you absolutely should immediately be putting that amount of money in your 401k. No questions asked :)

Good luck.




wwweb

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Re: Dumb Question from Newbie - Why max out 401k?
« Reply #3 on: October 03, 2015, 07:00:07 AM »
I would get $692 in my 401k for the net take home difference of $421 per paycheck.

This says it all. Saving in a 401k gives you more money to invest now. From your post, it sounds like you have some misconceptions about 401k plans.

But that would leave me very little to apply towards my VFINX.

You should be able to invest in VFINX or an equivalent index fund using the money in your 401k. You simply get to buy more if you use your 401k account because you buy with pretax dollars. The VFINX in your 401k also supports a 4% withdrawal for life.

why would I need a robust 401k to kick in when I turn 60?

401k accounts are not locked boxes that are inaccessible until you turn 60. For example, you can convert a 401k to a ROTH IRA and then after 5 years withdraw the amount converted tax and penalty free. You could do this at age 30 and have access to your money at age 35. Search ROTH ladder on the forums to learn more.

Having a good tax strategy is one of the most important things you can do to accelerate your FIRE date. Take some time to run the numbers and talk to someone you can trust about minimizing taxes.

Riff

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Re: Dumb Question from Newbie - Why max out 401k?
« Reply #4 on: October 03, 2015, 07:19:47 AM »
Here's our priority list:
1. Contribute to get the max company match in 401k
2. Max IRAs (we do Roths)
3. Max out 401k
4. Taxable accounts.

We haven't got past step 3 though.

IRAs have more flexibility and less fees than 401ks.

Left

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Re: Dumb Question from Newbie - Why max out 401k?
« Reply #5 on: October 03, 2015, 09:30:15 AM »
i dont understand why you would max roth ira first before 401k.... you still lose out on the tax benefits if you dont max 401k or traditional ira.

sure roths grow tax free, but you cant touch earnings so it is same as 401k for that. if you only care about principle, you get the same in a taxable account because both are post tax dollars used to buy shares with so you can the same number of shares.

i dont care much for the flexibility since i get the options i want in 401k, and not less fees for me either. 401k has more volume so they get lower fees sometimes. unless your company charges extra maintenance fees or something
« Last Edit: October 03, 2015, 09:32:29 AM by eyem »

Paul | pdgessler

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Re: Dumb Question from Newbie - Why max out 401k?
« Reply #6 on: October 03, 2015, 09:34:00 AM »
I'm still learning all this myself, but I think the reason to max (Roth) IRA first after maxing the match in a 401k is that in general, it's more flexible than typical employers' 401k offerings. You can open an IRA at Vanguard or wherever else you'd like, but with a 401k you're at the mercy of whatever your employer decides to offer you. So if you're fine with the 401k offerings, then go ahead and max that first.

lcerrito

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Re: Dumb Question from Newbie - Why max out 401k?
« Reply #7 on: October 03, 2015, 09:39:06 AM »
Thanks everyone!!! And yes, FIREby35, I didn't realize what I was worried about was liquidity. Thanks for the psychoanalysis, lol.

I didn't know about the Roth Ladder and 401k conversion. I'll research more into that. It would be amazing if I could max out my 401k and claim the tax benefits! Are any of you worried about the tax laws regarding backdoor Roth's changing before then though? I'm looking at around 15 years before ER.

Thanks again for your help in pointing me in the right direction!!!

Inkedup

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Re: Dumb Question from Newbie - Why max out 401k?
« Reply #8 on: October 03, 2015, 09:51:38 AM »
Tacking on another dumb question: if your 401k funds have higher ERs than anything you can get through Vanguard, won't those chip away at some of the gains over time? 
« Last Edit: October 03, 2015, 09:57:54 AM by Inkedup »

seattlecyclone

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Re: Dumb Question from Newbie - Why max out 401k?
« Reply #9 on: October 03, 2015, 10:01:39 AM »
I'm still learning all this myself, but I think the reason to max (Roth) IRA first after maxing the match in a 401k is that in general, it's more flexible than typical employers' 401k offerings. You can open an IRA at Vanguard or wherever else you'd like, but with a 401k you're at the mercy of whatever your employer decides to offer you. So if you're fine with the 401k offerings, then go ahead and max that first.

You get the flexibility with any IRA, whether it's Roth or traditional. Contributing to the traditional IRA gets you tax savings now, which is good if you (like most of us) plan to have less income and a lower tax bracket when we retire.

Tacking on another dumb question: if your 401k funds have higher ERs than anything you can get through Vanguard, won't those chip away at some of the gains over time? 

Yes, the higher expense ratios will chip away at the gains. Keep in mind that you can roll your 401(k) into an IRA with Vanguard when you change jobs, so you aren't stuck with your current employer's funds forever. Unless the funds are really bad and you're planning to work there for a couple of decades, the tax benefits of putting money into a 401(k) will outweigh the burden of the higher expense ratios.

Left

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Re: Dumb Question from Newbie - Why max out 401k?
« Reply #10 on: October 03, 2015, 10:02:56 AM »
higher ER would hurt the benefit, in that case do the ira after you get to matching

but i am not to the point where i am aiming to optimize/max on tax savings, just working ongetting both funded and into my portfolio at moment. if i miss a few tenths of percent on tax, i just tell myself at least i got the rest of the 99% invested

Inkedup

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Re: Dumb Question from Newbie - Why max out 401k?
« Reply #11 on: October 03, 2015, 10:09:19 AM »
higher ER would hurt the benefit, in that case do the ira after you get to matching

There is no matching at my workplace, unfortunately. The ERs in my plan, while not obscene, are still not that great, so I contribute only a modest amount. (It still adds up to more than what I put into each year's Roth IRA.)   
« Last Edit: October 03, 2015, 10:12:01 AM by Inkedup »

MDM

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Re: Dumb Question from Newbie - Why max out 401k?
« Reply #12 on: October 03, 2015, 10:27:09 AM »
higher ER would hurt the benefit, in that case do the ira after you get to matching

There is no matching at my workplace, unfortunately. The ERs in my plan, while not obscene, are still not that great, so I contribute only a modest amount. (It still adds up to more than what I put into each year's Roth IRA.)

You can quantify the difference between high fee 401k vs. low fee taxable.  See http://forum.mrmoneymustache.com/investor-alley/to-401k-or-not-to-401k-that-is-the-question-43459/.

clara2009

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Re: Dumb Question from Newbie - Why max out 401k?
« Reply #13 on: October 03, 2015, 02:23:06 PM »
No helpful answer from me, still new to the site - just wanted to say thanks for asking this question! I was wondering also!

Riff

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Re: Dumb Question from Newbie - Why max out 401k?
« Reply #14 on: October 03, 2015, 07:50:40 PM »
With 401ks, it's more than just expense ratios that you're charged for.  They're all different, and many (most, it seems) plans have hidden "maintenance" fees on top of the ER.  And it's not easy to figure out exactly what you're being charged. 

If you're not on board with a Roth IRA, go the traditional route and defer the taxes.