Author Topic: 401k vs. Personal Investments  (Read 12012 times)

jpluncford21

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401k vs. Personal Investments
« on: October 12, 2012, 12:44:11 PM »
I have been thinking about  this for some time now and haven't decided on an answer yet. You'll be able to tell from the rest of the post that relatively new to investing and still in the study/learning phase. I want you all to weigh in on this with thoughts and philosophies, etc.

I have the normal 401k with Fidelity offered through my employer. It offers some so so choices for investing, and is not very exciting. My issue with 401k's and other similar tax defered savings plans is that I can't touch them for the next 40 years without incurring some sort of penalty. Besides the benefits of lowering my income to another tax bracket, what's the point of having money in an account that I'm not allowed to touch. That seems like a way of being wealthy, but not really being wealthy.
With this thought process in mind, I'm more inclined to just invest my after tax income on my own so that I can do what I wish with my money. Is this the wrong way to think about investing? And if I am putting money into my 401k, what percentage should I put in? Should it be just up to the match, and then I handle the rest myself? Thanks for the help. I've only been here a week or so, but I'm loving this site

jpo

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Re: 401k vs. Personal Investments
« Reply #1 on: October 12, 2012, 01:27:41 PM »
http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/

There's a couple feasible options that MMM discusses in the article. Personally I am probably going to go for option 1 and FIRECalc 100% each "stage" (ER-65, then 65+).

hoppy08520

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Re: 401k vs. Personal Investments
« Reply #2 on: October 12, 2012, 01:37:36 PM »
Do you get a matching contribution from your employer? If so, then it's a no-brainer to invest in the 401(k) up to the point where you get the maximum employer match.

After that, if you can invest more, I'd put your next $5,000 into an IRA (either Roth or deductible Traditional depending on your circumstances and eligibility).  After that, I'd put your next money into the 401(k) up to $17,000. Then for any investable money after that, go to taxable investments.

I'd invest the money today to get the tax deduction today. By the time you withdraw, you're likely to be in a much lower tax bracket.

Per the link jpo posted, your tax-deferred money is not as locked away as you might think.


jpluncford21

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Re: 401k vs. Personal Investments
« Reply #3 on: October 15, 2012, 12:03:47 PM »
I have a company match for $0.50 up to 6%, so I match up to that...or I will. Currently I am throwing all of my money at debt. After that I will deposit up to my match, but still haven't decided what I'm going to do after that.

jpo

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Re: 401k vs. Personal Investments
« Reply #4 on: October 15, 2012, 12:13:54 PM »
I have a company match for $0.50 up to 6%, so I match up to that...or I will. Currently I am throwing all of my money at debt. After that I will deposit up to my match, but still haven't decided what I'm going to do after that.
Your debt is probably not at an interest rate of 50%, which is what you're giving up not having the match.

jpluncford21

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Re: 401k vs. Personal Investments
« Reply #5 on: October 15, 2012, 12:52:11 PM »
That is a good point. I will I will have to start investing that portion then. The ariticle mentioned (http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/) above doesn't really clear up my issues tho. Maybe I am being a little thick headed about it though.

okits

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Re: 401k vs. Personal Investments
« Reply #6 on: October 15, 2012, 08:42:46 PM »
Canadian here, so not intimately familiar with the mechanics of a 401k, but I'll give a perspective assuming its similar to an RRSP with an early-withdrawal penalty and attempt to answer what I think you're asking.

The main benefits to contributing are:

1) employer match, which is free money. (It won't take much to max out the matching, so you don't have to put up much to get the free money.)

2) tax-free compounding.  Your investment returns aren't taxed while the investments are in the account, so the money grows faster than if you had taxes continuously nibbling away at your returns.  Over time this compounds to grow you a bigger nest egg than if you had the same investments in a regular account.

3) deferring income from higher-tax-bracket years to lower-tax-bracket years.  Say today your marginal tax rate is 40%. On the last $1000 you earn in that particular year, you only get to keep $600. But what if you could wait to pay the taxes on that $1000, say in a year when your marginal rate is only 20%?  That $1000 of income you earned is now $800 in your pocket instead of only $600. Less for the tax man, more for you.  Plus the $1000 was growing tax-free in your 401k, so you are getting that double benefit.

For the undisciplined, retirement accounts theoretically make the money off-limits, so it's a form of forced savings, as well.  Of course, some people still cash them out, anyway, for a variety of reasons (some reasons, like to fund a spendy lifestyle, unquestionably bad.)

So think of your 401k as a tax-planning tool. The "right" amount to contribute depends on your income and tax bracket, debt situation, other tax-advantaged options you have, and how much of your investments you'll need to access before 65 versus how much you can put away right now, knowing you can't touch it (and hopefully won't need it) for years to come. 

If your employer's plan has lousy investment choices (and assuming you can open a 401k account independent of your employer; it's like that up here), I'd stick the minimum needed to get the entire employer match into the Fidelity account, then invest the rest in your own 401k account. If you can transfer funds out of the work Fidelity account into the one you set up, I'd do that periodically to get your money into investments of your choosing.  (This answer applies after you've decided what level of 401k contributions vs. debt repayment is optimal for your situation.)

Hopefully this helps answer what you were asking!

Mr. Sharma

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Re: 401k vs. Personal Investments
« Reply #7 on: October 15, 2012, 11:03:36 PM »
My issue with 401k's and other similar tax defered savings plans is that I can't touch them for the next 40 years without incurring some sort of penalty. Besides the benefits of lowering my income to another tax bracket, what's the point of having money in an account that I'm not allowed to touch. That seems like a way of being wealthy, but not really being wealthy.

There are a couple of ways to access these funds before retirement:

You can take a loan from your 401k on up to 50% of the account value not to exceed $50,000 (most plans have this, confirm with your company plan on whether this is allowable).  You will pay yourself back with interest from each paycheck over 5 years, 30 if used to purchase a home.  Caution: if you are separated from your job, the entire amount becomes dues.  If you can't pay it back, it's considered a distribution to you and you will pay the penalty.

Upon leaving the job, you can convert all or a portion of your traditional 401k to a Roth IRA.  Once converted, in about 5 years, you'll be able to withdraw the amount you converted tax/penalty free.

Upon leaving the job, you can rollover the traditional 401k to a traditional IRA.  You may then be able to use some exceptions (first time home purchase up to 10k, education expenses, medical beyond certain limits, etc...) to withdraw funds from the traditional IRA without having to pay a penalty. 

These are some of the more common ways to access those funds without paying a penalty.  It is after all a retirement savings account; it is not meant to be utilized before retirement.  Which means, don't put your emergency fund in there.  Where there's a will to touch the funds, there's a way.

hoppy08520

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Re: 401k vs. Personal Investments
« Reply #8 on: October 16, 2012, 07:26:35 AM »
Upon leaving the job, you can convert all or a portion of your traditional 401k to a Roth IRA.  Once converted, in about 5 years, you'll be able to withdraw the amount you converted tax/penalty free.
Note that when you convert a traditional 401(k) to a Roth IRA, you will pay taxes on the conversion (google "Roth IRA conversion").

Therefore, if you want to get at your 401(k) early, as described in the link to the MMM blog on this topic (see the section "Strategy 2: Use the Roth IRA Escape Hatch Loophole"), you should probably do this:

1. Upon separation from employment, roll over traditional 401(k) to traditional IRA. No tax consequences of doing so. Make sure you do the roll over correctly so it doesn't result in an unintended withdrawal.

2. Open a Roth IRA account, if you don't already have one.

3. Each year, convert a portion of your traditional IRA to the Roth IRA. This is a taxable event, so you'll only want to convert a portion of your traditional IRA so your taxable income doesn't creep up to a high bracket (maybe only convert up to the 10% tax bracket max, which for 2012 is $8,700 for single and $17,400 for married filing jointly).

4. Keep good records of these transactions, because after 5 years, you can withdraw the converted portion of your Roth IRA (but not the earnings) tax free.

5. Each year, loop back to 3 and/or 4 to generate a "ladder" or pipeline of conversions and withdrawals.