Author Topic: When is it ok to pass on 401k contributions?  (Read 4867 times)

raquel_belch

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When is it ok to pass on 401k contributions?
« on: December 19, 2014, 05:52:16 AM »
BACKGROUND: I'm a 29 year old professional woman living in a small town and making 55k/yr. I have no student or personal debt, no mortgage, no car payment. I have a 12k emergency fund and I maxed out my Roth IRA for 2013 and 2014. I also have about 180k in a UTMA account that my parents set up.  My boyfriend is in a similar situation - 28 years old, professional, 70k/yr, no personal debt, decent emergency fund, 2014 Roth maxed out, has almost paid off an apartment worth 120k. He doesn't worry about money as much as I do, but he's been receptive to learning and is slowly cutting back some of his expenses. We both have some serious expenses on the horizon though - a wedding in 2016, our cars are 10 and 12 years old, and I would like to have a child within the next five years.

QUESTION: After maxing out my Roth in 2015, I have the option of contributing to my office's 401k plan. There is no employer matching for contributions. Yesterday I showed my father the mutual funds and bond options that I can choose from. (My dad has been handling his own investments since I was a kid and is pretty talented. For example, he managed to take our church's account from ~$450k in 2006 to $1.5m today. He also manages my UTMA account, which has had a 24% return this year.) Anyway, he said that the expense ratio for the funds offered was way too high - around 1.3% for the specialty funds and 1.05% for the large-cap stock funds. He said he would skip 401k contributions all together which surprised me.

Is there some kind of calculator online that shows the expense related to a fund and the tax benefit work out over time? Or how long the expenses will eat up the tax savings? What are reasonable expense ratios for the average investor? And how common is it to skip your 401k all together?

I suppose I could just hand all of this over to my dad to manage but (1) I would like how to do this myself and (2) he's a wealthy man and his advice tends to be geared toward other wealthy people. For example, I was very late in starting to build a credit history because of his pay-in-cash mentality to just about everything, including real estate.

Any advice is appreciated. Thanks.

Cromacster

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Re: When is it ok to pass on 401k contributions?
« Reply #1 on: December 19, 2014, 06:26:55 AM »
The high fees do suck, but the tax benefit is still something that is hard to pass up.

JLCollins has a good writeup on when to consider skipping a company 401(k).

Should you avoid your company’s 401k?

Quote
Go for it if:
Your tax bracket is 25% or higher.
Your 401k deduction will lower your income enough to get the EIC.
Your employer offers a match, and then contribute only up to the match ceiling.

Consider skipping it if:
Your tax bracket is 15% or less.
Your employer doesn’t offer a match.
You think your tax bracket might well be higher than 15% in retirement.

Also note:

Quote
Reading the Mad Fientist‘s thoughtful case it is clear — most often you’ll be money ahead funding your 401k. Given the highway robbery now imbedded in so many of them, that’s tough for me to say. But there it is.

Madfientist - Retire Even Earlier
« Last Edit: December 19, 2014, 06:35:34 AM by Cromacster »

NICE!

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Re: When is it ok to pass on 401k contributions?
« Reply #2 on: December 19, 2014, 10:14:18 AM »
OP - I'd run from those fees. Don't know if anything is worth over 1%, particularly if the options are terrible.

This is all news to me since my original, very good, financial education (which was my upbrining + a course in college + lots of reading) said go Roth every time and max everything. For example, I have a Roth IRA and Roth 401k. My AGI ends up somewhere in the 50s or 60s (I can't remember because there is a lot of non-taxable income for military and we move often, changing those #s)

But now, I'm being told that if I want to FI I should be looking at Traditional IRAs and perhaps avoiding the 401k entirely. My problems are the following:

1) The TSP is considered one of, if not the best, 401k in the business. I have no matching, but have microscopic fees on my funds.
2) DW plans on working longer than I do (probably into her 50s, particularly if I stop working or work less. We share finances).
3) We're about 1/3 of the way to FI and should be there in 5-10 years (depending on returns and overseas COL).
4) I might stay in long enough to get the military pension (which should be enough for FI on its own).

What should I be doing? I expect income to continue to go up for 10+ years, especially because I believe a few of them will be dual-income. After that it will either stay flat or taper off a bit (due to her being in a lower-paying field).

epipenguin

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Re: When is it ok to pass on 401k contributions?
« Reply #3 on: December 19, 2014, 11:06:23 AM »
Do you have a high deductible health plan with access to an HSA? If yes, I'd probably max the HSA in preference to the 401k.

Do you intend to stay at this job for a long time? If you're only intending to stay another couple of years, then the current high fees will be a moot point once you leave - you can either roll over to a new employer's 401k or an IRA.

Edit: Is there a chance to sit down with a 401k person at work to discuss their plan? If so, ask if there is any other type of contribution that the employer might make to the 401k to make it more appealing (for example, I get an optional profit sharing contribution, not a match). Also, you can raise your concerns about the fees to them. They might even be clueless that the fees causing an issue (or they may not care, but at least raise the point with them).
« Last Edit: December 19, 2014, 11:09:08 AM by epipenguin »

raquel_belch

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Re: When is it ok to pass on 401k contributions?
« Reply #4 on: December 19, 2014, 11:08:42 AM »
Thanks for the link, Cromacster. It was very informative and helped my feel that not going for the 401k tax benefits may not be totally insane.

The website they link to (www.401kfee.com) is exactly the kind of calculator I was looking for. I found that if I contribute $6500/yr for the next 35 years, then a fund with an expense ratio of 1.39% will cost me about $2k/yr and $311k over my working career compared to an index with an expense ratio of .2%. That's eye opening, even if it doesn't calculate the savings against the tax benefits.

Quote
Go for it if:
Your tax bracket is 25% or higher.
Your 401k deduction will lower your income enough to get the EIC.
Your employer offers a match, and then contribute only up to the match ceiling.

Consider skipping it if:
Your tax bracket is 15% or less.
Your employer doesn’t offer a match.
You think your tax bracket might well be higher than 15% in retirement.

[/quote]

I'm right at that 25% tax bracket, but I don't benefit from the EIC and I don't get any matching. Also my dream retirement would only be a semi-retirement where I have a very flexible part-time work schedule as a senior partner and I still pull in six figures every year. I'm not sure how realistic that is, but it's definitely a goal I'm working toward. That's just a long way of saying that I plan and hope that my tax bracket will be higher than 15% in retirement.

It's a tough choice...

raquel_belch

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Re: When is it ok to pass on 401k contributions?
« Reply #5 on: December 19, 2014, 11:20:10 AM »
Do you have a high deductible health plan with access to an HSA? If yes, I'd probably max the HSA in preference to the 401k.

Do you intend to stay at this job for a long time? If you're only intending to stay another couple of years, then the current high fees will be a moot point once you leave - you can either roll over to a new employer's 401k or an IRA.

Edit: Is there a chance to sit down with a 401k person at work to discuss their plan? If so, ask if there is any other type of contribution that the employer might make to the 401k to make it more appealing (for example, I get an optional profit sharing contribution, not a match). Also, you can raise your concerns about the fees to them. They might even be clueless that the fees causing an issue (or they may not care, but at least raise the point with them).

I'm going to confess my ignorance -- I don't know if I have a high deductible or not. It's $500/family member and my out of pocket limit for copayment is $2k. That seems reasonable to me, but I've been healthy and it might not be reasonable to other people. I don't believe we have access to an HSA but I can look into it. Thank you for the suggestion.

And yes, I do plan on staying at this job for a long time. I can definitely try to speak with HR, but we only just got direct deposit in my office and that literally took years of requests - haha. Still, it's definitely worth a discussion. Thanks again!

BarkyardBQ

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Re: When is it ok to pass on 401k contributions?
« Reply #6 on: December 19, 2014, 01:30:42 PM »
Check and see if your 401k custodian/employer offer in-service rollovers. If you can defer the income and reduce your taxes you can move your 401k balance over to something like a Vanguard Traditional IRA and pick better funds. But your tax relief (~$4500) for 1 year on that income would out pace those expenses on up to 18k.
« Last Edit: December 19, 2014, 01:33:28 PM by zdravé »

epipenguin

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Re: When is it ok to pass on 401k contributions?
« Reply #7 on: December 19, 2014, 02:32:08 PM »
Do you have a high deductible health plan with access to an HSA? If yes, I'd probably max the HSA in preference to the 401k.

Do you intend to stay at this job for a long time? If you're only intending to stay another couple of years, then the current high fees will be a moot point once you leave - you can either roll over to a new employer's 401k or an IRA.

Edit: Is there a chance to sit down with a 401k person at work to discuss their plan? If so, ask if there is any other type of contribution that the employer might make to the 401k to make it more appealing (for example, I get an optional profit sharing contribution, not a match). Also, you can raise your concerns about the fees to them. They might even be clueless that the fees causing an issue (or they may not care, but at least raise the point with them).

I'm going to confess my ignorance -- I don't know if I have a high deductible or not. It's $500/family member and my out of pocket limit for copayment is $2k. That seems reasonable to me, but I've been healthy and it might not be reasonable to other people. I don't believe we have access to an HSA but I can look into it. Thank you for the suggestion.

And yes, I do plan on staying at this job for a long time. I can definitely try to speak with HR, but we only just got direct deposit in my office and that literally took years of requests - haha. Still, it's definitely worth a discussion. Thanks again!

Yeah, it seems like that is not a high deductible plan. That's probably a regular PPO.

Don't be discouraged on the 401k thing after you speak to HR. If it's actually impacting you signing up, they may be inclined to at least listen. I used to ask HR at my employer for low cost Vanguard funds and they would totally just ignore me or say that the investment committee would carefully consider all the options, but they'd pass my request on, blah blah blah. Nothing would happen. And then a few years later we got some Vanguard funds. Because the investment committee thought it was a good idea. [I don't think I had any direct influence at all, but I like to think that maybe a few different people asked, and it maybe got them thinking, so perhaps I had some very small part in that change.]

MDM

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Re: When is it ok to pass on 401k contributions?
« Reply #8 on: December 19, 2014, 03:03:53 PM »
That's eye opening, even if it doesn't calculate the savings against the tax benefits.

It's a tough choice...
When you include the tax effects (and unless the IRS disappears you should include the tax effects) the difference becomes much less.  For the numbers you give (1.39% fee in 401k, 0.2% fee in taxable, 25% ordinary bracket) the difference in after-tax amount after 35 years is ~$400 out of ~$640,000 if there is no employer match.

If, however, the employer kicks in $1000/yr so you the 401k gets $7500 instead of $6500 you have ~$100,000 more after those 35 years.

Not saying anything contrary to what Mr. Collins advised....

maizefolk

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Re: When is it ok to pass on 401k contributions?
« Reply #9 on: December 20, 2014, 07:39:34 PM »
When you include the tax effects (and unless the IRS disappears you should include the tax effects) the difference becomes much less.  For the numbers you give (1.39% fee in 401k, 0.2% fee in taxable, 25% ordinary bracket) the difference in after-tax amount after 35 years is ~$400 out of ~$640,000 if there is no employer match.

If, however, the employer kicks in $1000/yr so you the 401k gets $7500 instead of $6500 you have ~$100,000 more after those 35 years.

Not saying anything contrary to what Mr. Collins advised....

Does that take into account the advantage of the 401K balance growing tax free, or are you just considering the initial income tax hit or lack thereof? The former is going to be variable depending on investment strategy, but still significant when compounded over a 35 year time frame.

MDM

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Re: When is it ok to pass on 401k contributions?
« Reply #10 on: December 20, 2014, 07:48:50 PM »
Does that take into account the advantage of the 401K balance growing tax free, or are you just considering the initial income tax hit or lack thereof? The former is going to be variable depending on investment strategy, but still significant when compounded over a 35 year time frame.
Good question!  Calculations assumed a 2% dividend yield taxed at 15% for the taxable account.

Nords

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Re: When is it ok to pass on 401k contributions?
« Reply #11 on: December 20, 2014, 08:48:38 PM »
OP - I'd run from those fees. Don't know if anything is worth over 1%, particularly if the options are terrible.

This is all news to me since my original, very good, financial education (which was my upbrining + a course in college + lots of reading) said go Roth every time and max everything. For example, I have a Roth IRA and Roth 401k. My AGI ends up somewhere in the 50s or 60s (I can't remember because there is a lot of non-taxable income for military and we move often, changing those #s)

But now, I'm being told that if I want to FI I should be looking at Traditional IRAs and perhaps avoiding the 401k entirely. My problems are the following:

1) The TSP is considered one of, if not the best, 401k in the business. I have no matching, but have microscopic fees on my funds.
2) DW plans on working longer than I do (probably into her 50s, particularly if I stop working or work less. We share finances).
3) We're about 1/3 of the way to FI and should be there in 5-10 years (depending on returns and overseas COL).
4) I might stay in long enough to get the military pension (which should be enough for FI on its own).

What should I be doing? I expect income to continue to go up for 10+ years, especially because I believe a few of them will be dual-income. After that it will either stay flat or taper off a bit (due to her being in a lower-paying field).
I concur with maxing out the TSP contributions.  Most servicemembers in lower tax brackets prefer to pay the taxes now and contribute to the Roth TSP.

I don't understand why anyone would contribute to a traditional IRA if they could contribute to a Roth IRA.  It's much easier to tap the funds of a Roth IRA (for example, withdrawing contributions at any time for any reason with no taxes or penalties).  Most of the discussion of traditional IRAs revolves around how to efficiently convert them to Roth IRAs.

I'd max out the Roth TSP whether or not you think you're going to get a military pension.  But if you're otherwise committed to the pension then I'd absolutely max out the TSP contributions.