Max 401k or allocate to Taxable Account?

[Tonyahu]

Hey MMers,

I am currently 25, male, just starting my career (30k/yr) and am aiming to be financially independent / early retire around the age of 45.

I am starting the accumulation phase and am wondering what would be better to do at first (Roth IRA already being maxed):

- Contribute to 401k $5,000 yearly

or

- Contribute up to 401k match, then allocate those funds to taxable account


I assume that if I am FI by 45, I would be pulling from my taxable account, so maybe I should start adding to that taxable account first before looking to max my 401k. Obviously in the future the 401k would be maxed while additionally contributing to the taxable, but I am wondering best order of operations here.

Open to any and all suggestions and information.

Thanks!

[MrDelane]

Take a look at these two threads, I think they'll be very helpful:
https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

https://forum.mrmoneymustache.com/investor-alley/investment-order/

Putting money in your 401k would probably be the best move, in my opinion.
You said you were maxing out the Roth already, so I assume you also have an emergency fund as well.
Once your income grows enough to max out the 401K and you still find yourself with more to save, then you can start putting it away in a taxable account.

And by the way - congrats on being so ahead of the game.
I wish I'd had your foresight when I was 25.

Keep it up!

[SeattleCPA]

Taking the match is a no-brainer, IMHO. Free money.

After that, it gets trickier, I think.

You may not get that much benefit from a Roth account because your contributions to the account deliver no tax savings... and because your income in a taxable account, if it's all qualified dividends and long-term capital gains, will very possibly be tax free. Also, you do lose some options via the Roth: Foreign tax credits, option of doing some alternative asset class deal (like buy a house or rental)...

Note: If your income will rise in future working years, I think the Roth makes more sense.... It probably even becomes no-brainer.

[Tonyahu]

Taking the match is a no-brainer, IMHO. Free money.

After that, it gets trickier, I think.

You may not get that much benefit from a Roth account because your contributions to the account deliver no tax savings... and because your income in a taxable account, if it's all qualified dividends and long-term capital gains, will very possibly be tax free. Also, you do lose some options via the Roth: Foreign tax credits, option of doing some alternative asset class deal (like buy a house or rental)...

Note: If your income will rise in future working years, I think the Roth makes more sense.... It probably even becomes no-brainer.

Interesting.

If I am in the $38,000 and under bracket during retirement, pulling only long term cap gains / qualified dividends, does that leave me at the 0% or 15% taxes?

[MDM]

If I am in the $38,000 and under bracket during retirement, pulling only long term cap gains / qualified dividends, does that leave me at the 0% or 15% taxes?

0% federal.  See the case study spreadsheet for confirmation.

Don't know about state taxes - they can be nonzero for LTCG and QD even when the federal tax is $0.

[MustacheAndaHalf]

I am currently 25, male, just starting my career (30k/yr) and am aiming to be financially independent / early retire around the age of 45.
...
- Contribute to 401k $5,000 yearly

I hope other things will drive your retirement, since saving $100,000 (plus growth) is likely to give you only $500/mo or so to spend in retirement (including rent).  Between age 45 and 67 you're likely to see that $500 buy closer to $250 worth of goods owing to inflation.

The company match comes first since that's free money for employees.  I would agree with contributing to an IRA after the match, since you have control of that money.  No need to put it in taxable - just open an IRA at Vanguard and invest there.  Your $5,000/year contributions (less 401(k) contributions) is below the contribution limit for IRAs.

[SeattleCPA]

Taking the match is a no-brainer, IMHO. Free money.

After that, it gets trickier, I think.

You may not get that much benefit from a Roth account because your contributions to the account deliver no tax savings... and because your income in a taxable account, if it's all qualified dividends and long-term capital gains, will very possibly be tax free. Also, you do lose some options via the Roth: Foreign tax credits, option of doing some alternative asset class deal (like buy a house or rental)...

Note: If your income will rise in future working years, I think the Roth makes more sense.... It probably even becomes no-brainer.

Interesting.

If I am in the $38,000 and under bracket during retirement, pulling only long term cap gains / qualified dividends, does that leave me at the 0% or 15% taxes?

Here's an approach you can use to model your real tax burden:

http://evergreensmallbusiness.com/income-tax-buckets-not-income-tax-brackets/

Also, MDM makes a very important point about state taxes... Don't miss that.

[Khan]

The math shows that pre tax dollars is the most efficient investing strategy. This comes down to deferring/delaying taxes(which is always fantastic, unless you believe rates will rise markedly), and pulling money out and filling up 0% and 15% tax brackets vs saving at your highest marginal tax bracket(which currently isnt that high but hopefully will increase shortly).
http://www.madfientist.com/retire-even-earlier/

However: you need to have cash available, and cash equivalents to slide through life. You need an emergency fund of some sort, many of us have opted to forgo an emergency fund for a taxable investment account of around double or more of the typical emergency fund savings, and/or some type of springy debt cushion(HELOC, margin loan access, credit card forwarding). Having more available cash like assets also increases your flexibility, such as if you're so inclined taking advantage of real estate opportunities, being able to move and not earn for a while, etc.

You can access 401k monies through all the known mustachian ways before 55/59 1/2, but just consider having some flexibility with your thoughts on this.

[Tonyahu]

Thanks for the input from all! Any additional information is gladly appreciated! I will save this post and refer back to it to keep myself informed, lots of good reference materials in here.

I hope other things will drive your retirement, since saving $100,000 (plus growth) is likely to give you only $500/mo or so to spend in retirement (including rent).  Between age 45 and 67 you're likely to see that $500 buy closer to $250 worth of goods owing to inflation.

The company match comes first since that's free money for employees.  I would agree with contributing to an IRA after the match, since you have control of that money.  No need to put it in taxable - just open an IRA at Vanguard and invest there.  Your $5,000/year contributions (less 401(k) contributions) is below the contribution limit for IRAs.

I may have not made my first post clear, I am just starting my career at $30,000 annually. This will grow tremendously over the next ~20 years...

[MDM]

The math shows that pre tax dollars is the most efficient investing strategy. This comes down to deferring/delaying taxes(which is always fantastic, unless you believe rates will rise markedly), and pulling money out and filling up 0% and 15% tax brackets vs saving at your highest marginal tax bracket(which currently isnt that high but hopefully will increase shortly).
http://www.madfientist.com/retire-even-earlier/

Be careful on this analysis.  For each contribution, it's the marginal rate at which one saves vs. the marginal rate at which that contribution will be taxed when withdrawn, that should be used for the traditional vs. Roth decision.

See Marginal tax rate - Traditional_vs._Roth - Bogleheads for more.