Author Topic: Questioning the advice to max the 401k.  (Read 15743 times)

okashira

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Re: Questioning the advice to max the 401k.
« Reply #50 on: July 08, 2014, 10:19:46 AM »
I would max the 401k. It's not the best, but not completely terrible.

Since your husband makes high income, and you want to be mustachian (that is why you are here, right?) you can easily get 55%+ savings rate on that income. You'll need the 401k max PLUS a roth ira max PLUS addl savings in a taxable, unless your debts are high.

What does this mean for your 401k?
I would look at the best two funds and stick with them. Note the asset allocations in those funds. With only two funds you will probably be weighted too heavily in one direction (say US stock or US bonds)
So you will just take note of this and adjust your investments in your ROTH IRA and your Taxable account to balance everything out.
You can take your time with this. What I mean is:
1. start maxing the 401k now.
2. Research and pick your two funds and set them (existing balances and future contributions)
3. Open your ROTH and set your funds and contributions
4. Open your taxable and set your funds and contributions.

Look at % going into each fund in each account as if it were a single accound calculate your asset allocation that way.


If there is a good bond fund or an international stock fund or REIT fund in that 401k, I would lean toward those since this is a tax advantaged account.

Daisy

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Re: Questioning the advice to max the 401k.
« Reply #51 on: July 08, 2014, 10:35:13 AM »
Plus, once you turn 62-70 and begin receiving Social Security, you almost certainly will have to pay taxes from 401k or IRA withdrawals.

Good point. I haven't thought too much about this, because who knows what my Traditional IRA balances will be when I start collecting Social Security at 62. I guess this is a good argument to start that Traditional to Roth conversion pipeline as early as possible. Since this conversion is taxable income, we will have to play a delicate game of withdrawing as little as possible each year to minimize taxes and enough to qualify for ACA subsidies. The addition of Social Security income at 62 will have to be managed as well. Once you hit Medicare at 65 then the ACA subsidy game may subside (I think?).

To the OP - For a few years now I had also been minimizing contributing to the 401k since I thought I needed taxable investments to get me going to 59.5. But after learning about the Roth conversion pipeline, I have now gone back to maxing out my 401k contributions. Such a wonderful little thing to learn about...

Cheddar Stacker

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Re: Questioning the advice to max the 401k.
« Reply #52 on: July 08, 2014, 10:45:54 AM »
Plus, once you turn 62-70 and begin receiving Social Security, you almost certainly will have to pay taxes from 401k or IRA withdrawals.

Good point. I haven't thought too much about this, because who knows what my Traditional IRA balances will be when I start collecting Social Security at 62. I guess this is a good argument to start that Traditional to Roth conversion pipeline as early as possible. Since this conversion is taxable income, we will have to play a delicate game of withdrawing as little as possible each year to minimize taxes and enough to qualify for ACA subsidies. The addition of Social Security income at 62 will have to be managed as well. Once you hit Medicare at 65 then the ACA subsidy game may subside (I think?).

To the OP - For a few years now I had also been minimizing contributing to the 401k since I thought I needed taxable investments to get me going to 59.5. But after learning about the Roth conversion pipeline, I have now gone back to maxing out my 401k contributions. Such a wonderful little thing to learn about...

This is also a good reason to consider delaying your social security benefits to allow for more Roth conversions first. I'm not saying it should be what you base your decision on, but one of the factors in deciding when to draw your SS.

pom

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Re: Questioning the advice to max the 401k.
« Reply #53 on: July 08, 2014, 11:01:40 AM »
I may have missed it so my apologies if this was discussed already.

It is true that the fees paid are ridiculous but have you considered for how long you will pay them?

When I left my job I was able to transfer my 401k balance to an IRA and buy S&P500 etfs with fees of less than 0.1%. My point is that the higher fees are not necessarily there until retirement. If you FIRE relatively quickly you will end up paying that 1% a year for only a few years.

Another Reader

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Re: Questioning the advice to max the 401k.
« Reply #54 on: July 08, 2014, 11:33:42 AM »
It seems to me you are worrying about the wrong things.  The Roth pipeline and putting a lot of money into taxable paper investments are important for someone that is in their 20's and wants to retire in their 40's.  In your case, you are already in your 40's.  Your savings rate is not exceptionally high, and the likelihood of reaching FI much before age 59 1/2 is relatively low.  Once your husband reaches that age, the withdrawals from his tax deferred accounts are only subject to ordinary income tax.  Your taxable income will likely be in the 15 percent bracket at that point.  You can have a taxable income of up to $73,800 this year as a married couple and be in the 15 percent bracket in 2014, and that will be indexed each year.  That's taxable income, after all exemptions and deductions.  Any Roth account withdrawals will be tax free.

When there is more net income available, your investment options are broader.  If you want to speed up FI, you will have to earn more money or cut your spending and invest the savings.  If you think you are going to trade your way to FI, well, good luck with that.  You do not seem willing to make the sacrifices that others made to acquire enough income producing real estate to get you to FI, either. 

In your shoes, I would focus on those things that will get me to FI without making the sacrifices I am not willing to make.  Max out the 401k, invest what you can in IRA's, and squeeze some air out of your expenses to fund the taxable investing side, whether the investments are paper or real estate.

KBecks2

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Re: Questioning the advice to max the 401k.
« Reply #55 on: July 08, 2014, 12:09:25 PM »
OK, yes, we are not 20 something.  We are mid-40s.  And our savings rate is a work in progress.  Although I have posted about restaurant meals and our remodeling, it doesn't mean we don't care about our savings rate.  It is something we want to work on.

A previous poster said, save 55%, piece o' cake.  And, that's probably not a piece of cake for us, but it will be a very interesting experiment and game to see how much we can save and how high we can get. :-) 

We may not have spending as low as the MMM family.  But that does not mean we are not willing to or able to save.  Anotherreader, I am not sure where you are saying that we are unwilling to sacrifice, or who you are comparing us to, or why.  But OK, challenge me and our sacrifice and ability to save, that is OK.  The overall information is helpful. Thanks so much. 

We are not retiring immediately, but I would call retirement at age 50 - 55 instead of 65 a great success.  Or a success for us.  That is OK. 

OK, back to the budget! 
« Last Edit: July 08, 2014, 12:15:11 PM by KBecks2 »

Another Reader

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Re: Questioning the advice to max the 401k.
« Reply #56 on: July 08, 2014, 12:29:13 PM »
Time to FI is all about the savings rate.  Your husband makes around $100k.  If he maxes the 401k and gets the paltry match, that's 18.5 percent of gross income.  If you can get two Roth's in, that's another 11 percent of gross income.  You are almost at 30 percent.  Maybe 35 percent with the other money you are investing.

However, you need to get to $1.25M, per your own statement.  How do you intend to do that at your current savings rate?  What will change that will put you in a position to have $1.25M in 5 to 10 years?

KBecks2

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Re: Questioning the advice to max the 401k.
« Reply #57 on: July 08, 2014, 12:40:06 PM »
I do expect our investments to grow in value over the next 10 years -- is that wrong?   

Perhaps it's too optimistic, but I was even thinking that if our current savings simply double in value in the next 10 years (rule of 72) that we will be at goal, because we are currently halfway there.  I would need to earn about 7% annually.  Of course we will keep saving, though!



« Last Edit: July 08, 2014, 12:49:06 PM by KBecks2 »

Another Reader

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Re: Questioning the advice to max the 401k.
« Reply #58 on: July 08, 2014, 01:10:56 PM »
No, but maybe the goal is a little on the low side for 10 years in the future.  While your investments are increasing and compounding, so is the cost of what you consume.  You may need $80k in 10 years to cover $40-$50k of spending in today's dollars.

What I'm really trying to convey is you enhance your chances of achieving what you want by consistently investing the maximum in tax deferred/tax free accounts and then investing on the taxable side.  Your relatively short time horizon makes the tax deferral especially useful.  There are no "magic bullets" on the taxable side that will replace investing in the retirement accounts.

catccc

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Re: Questioning the advice to max the 401k.
« Reply #59 on: July 08, 2014, 01:59:29 PM »
Thought I'd chime in... another vote for maxing out the 401K.

KBecks2

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Re: Questioning the advice to max the 401k.
« Reply #60 on: July 08, 2014, 02:00:28 PM »
OK, good.  The 401k is not something that I get excited about, and the fund choices are not fun either.  Honestly, they all start to look / sound the same.  I am not sure how to compare and select, but I like your advice to pick the one with the lowest fee, the T Rowe Price that seems decent, or to pick just one or two and then seek balance it among our taxable investments.

The stock service that I follow for our taxable portfolio has a mission of inflation + 7%, with no loss of capital over a 3-5 year period. That is their guideline/target that they measure by.  And so their strategies include options and hedging to lower cost basis and reduce risk, and it is a fairly conservative portfolio.  They are looking for "cash machine" type stocks, and I like their philosophy very much.

I hold a few extra stocks that I like, to personalize things.  Some are very steady companies, big brands, a few are emerging / more speculative. (small $ there).  I have a lot of fun with doing my own investing.  That is why I am so much more interested in that side of things.

Over the past 6 months or so, I did a thorough spreadsheet that documents all of our taxable investments, so that I can see what we own all in one place.  I went through everything and it was a big process to make it.

Generally, I prefer stock investing and I prefer American companies (so many US companies are in international markets.) I would like to try real estate land lording where I live.  There are some opportunities that look good and it would be a good business to learn.  However, I could also start to learn about notes.  We aren't quite cash account heavy enough to do much with real estate at this point, but I would love to diversify from the stock portfolio with real estate.


« Last Edit: July 08, 2014, 02:02:59 PM by KBecks2 »

v10viperbox

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Re: Questioning the advice to max the 401k.
« Reply #61 on: July 08, 2014, 02:07:36 PM »

But the fees on 401(k)s are not just a one time charge. The fees continue every year of investments. So let's say it's a 1% fee annually. I need to look into it further, but most of the funds offered in the plan we have access to are around 1% of assets annually.  Emphasis on the recurring fees vs. a one time tax savings.

Also, I am expecting that my individual performance will outpace the 401(k). Unfortunately, our 401(k) does not involve low-cost Vanguard funds. If they did, I wouldn't be so concerned.

We use Vanguard as our main brokerage, and I could easily split our contributions into a Vanguard mutual funds, and save a slice for real estates or active investing, or any other option we feel like.

Also, the actual tax savings is not $17,500. The tax savings is $17,500 times your effective tax rate. So our tax bracket is 25%.  $4,375, if we contributed the maximum amount.

It is true that the 1% would be recurring. But since the contributions are also recurring, then you would need to beat the market average by a significant margin every year to make up for the tax savings.

To take a simple example:

Assume market average of 7% and fees of 1% in 401k.

Option 1: Invest in 401k
7500 * 1.06^30 = 43,076

Option 2: Invest Difference
(7500 * .75) * 1.07^30 = 42,819

You'll see that even in this example, you would still not come out ahead after 30 years. And keep in mind that this would be for one contribution year. You would likely still have other contribution years that would have less time to take advantage of compounding.

The difference is even more pronounced over shorter time frames. If you want to retire early and have access to these funds early, then you're going to be better off in most cases contributing the full amount to the 401k.

This disregards the long term tax rate implications of investing post vs pretax money though. You can over-save pretax by a significant margin and end up shooting yourself in the foot in the long run, well not really your have the cash.

Tax rates are a very fluid thing and this only happens in very rare cases but yes you can do better mathematically by buying in a current a known lower tax rate then deferring and paying after a required disbursement.

Thedudeabides

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Re: Questioning the advice to max the 401k.
« Reply #62 on: July 08, 2014, 08:32:16 PM »


But the fees on 401(k)s are not just a one time charge. The fees continue every year of investments. So let's say it's a 1% fee annually. I need to look into it further, but most of the funds offered in the plan we have access to are around 1% of assets annually.  Emphasis on the recurring fees vs. a one time tax savings.

Also, I am expecting that my individual performance will outpace the 401(k). Unfortunately, our 401(k) does not involve low-cost Vanguard funds. If they did, I wouldn't be so concerned.

We use Vanguard as our main brokerage, and I could easily split our contributions into a Vanguard mutual funds, and save a slice for real estates or active investing, or any other option we feel like.

Also, the actual tax savings is not $17,500. The tax savings is $17,500 times your effective tax rate. So our tax bracket is 25%.  $4,375, if we contributed the maximum amount.

It is true that the 1% would be recurring. But since the contributions are also recurring, then you would need to beat the market average by a significant margin every year to make up for the tax savings.

To take a simple example:

Assume market average of 7% and fees of 1% in 401k.

Option 1: Invest in 401k
7500 * 1.06^30 = 43,076

Option 2: Invest Difference
(7500 * .75) * 1.07^30 = 42,819

You'll see that even in this example, you would still not come out ahead after 30 years. And keep in mind that this would be for one contribution year. You would likely still have other contribution years that would have less time to take advantage of compounding.

The difference is even more pronounced over shorter time frames. If you want to retire early and have access to these funds early, then you're going to be better off in most cases contributing the full amount to the 401k.

This disregards the long term tax rate implications of investing post vs pretax money though. You can over-save pretax by a significant margin and end up shooting yourself in the foot in the long run, well not really your have the cash.

Tax rates are a very fluid thing and this only happens in very rare cases but yes you can do better mathematically by buying in a current a known lower tax rate then deferring and paying after a required disbursement.

Yes, this is indeed an important consideration and should have been pointed out in my original post. Depending on your current age and anticipated tax bracket at retirement the fact that you will have to pay income tax on distributions could have a big impact if you're in a high tax bracket at retirement. If you're planning on being in a low tax bracket, then it will have a lower impact, or no impact if plan on setting up a ROTH conversion latter.

Bottom line is that it can't be left out of the analysis.

Zamboni

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Re: Questioning the advice to max the 401k.
« Reply #63 on: July 08, 2014, 09:00:43 PM »
Threads like this remind me that most people don't understand what tax brackets are or how they work.  At your income, the money you earn is taxed in several different brackets. 

Here is a short explanation for your enjoyment:
Quote
http://www.learnvest.com/knowledge-center/tax-brackets-explained/