Author Topic: 401k vs after tax savings?  (Read 5603 times)

Jessa

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401k vs after tax savings?
« on: August 25, 2014, 05:17:45 AM »
I have just about $20k/year that I can invest for my retirement. I think I will be able to retire at 50, if I keep a steady savings rate. Conventional wisdom holds that I should max out my 401k, but since I can't touch that until I'm at least 59 1/2, should I be putting a larger portion into after tax savings to support me between when I retire and when I have access to my 401k?

MMM mentioned some things I don't quite understand about converting 401k into an IRA and then withdrawing early after 5 years...I do have a 401k from a previous company (there's about $57k in there) that I could roll into an IRA, I just didn't really follow what the tax implications were on that.

matchewed

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Re: 401k vs after tax savings?
« Reply #1 on: August 25, 2014, 05:38:12 AM »
Sorry if I appear rather flippant with my response as this is well worn ground around these parts. Well there are a couple of things going on here. First is taxes. This one is a rather simple math problem in that paying 15% or more to earn 7% return will always lose to just earning the 7% return, that is pre-tax investing will save you more money in a shorter time frame. Second is the Roth pipeline or Roth conversion ladder. Read these posts.

http://www.madfientist.com/roth-ira-horse-race/
http://jlcollinsnh.com/2013/12/05/stocks-part-xx-early-retirement-withdrawal-strategies-and-roth-conversion-ladders-from-a-mad-fientist/
http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/

Aphalite

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Re: 401k vs after tax savings?
« Reply #2 on: August 25, 2014, 07:21:16 AM »
Rolling an IRA to a roth IRA counts as income, so if you were to do that while you were still earning a salary, you wouldn't realize the tax benefits of rolling stuff over after you were retired.
Read the links above and come back if you have any questions after that.

nordlead

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Re: 401k vs after tax savings?
« Reply #3 on: August 25, 2014, 08:10:31 AM »
You really need to post a lot more information if you want good advice. (like, current account assets, tax brackets, age, expenses, etc...)

You can access a 401k at 55 if you work until 55. Or, you could take equally payments (which isn't optimal, but works), so your 401k can be accessed early. There are more options than just the Roth pipeline.

Also, assuming your 20k is after tax, I'd probably max out the 401k, which would leave you 2.5k + 17.5k*<taxrate> to invest in a Roth or taxable account. A 5k/17.5k split might be enough to hold you over from 50 to 60.

Jessa

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Re: 401k vs after tax savings?
« Reply #4 on: August 25, 2014, 10:35:27 AM »
Current Assets:
$57k in a previous company's 401k
$1.3k in current company's 401k
$3k in after tax investments
$6k in a CD that matures this month that I'm planning to invest in mutual funds
$6k in emergeny savings.

I'm currently 34, hoping to retire at 50. My expenses this year were not very Mustachian, but I've been working on being more frugal. I'm assuming at this point that my expenses will be $17,300 for next year. I should be able to keep it under that, but I like to be conservative. My gross pay is $50k. I'm currently contributing 20% to my 401k, so $384/paycheck (bi-weekly). My effective tax rate is 28% (federal, state, FICA). (I'm not yet eligible for 401k matching, it will be .5% up to 2% when it kicks in, but I'm not factoring that extra 1% in yet)

Originally my plan was to continue contributing 20% to my 401k (assuming a 2% raise every year) and taking $350/paycheck after taxes to invest. That should give me enough to live off for 10 years, then at 60 start withdrawals from my 401k.

Now I'm thinking (after going through the posted articles) I should max out my 401k to the $17,500 starting next year, and only have about $125/paycheck for after tax investing. Convert my 401k to an IRA as soon as I retire, and do the Roth conversion pipeline. My only concern is that my after tax nest egg will be much smaller and I'll have less flexibility in that first 10 years. But if I do it my way, I'm only saving $19.3k next year; if I max out the 401k I can save at least $21k, and over time it would be at least $30k extra, so it does seem to make more sense to do it that way.

MDM

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Re: 401k vs after tax savings?
« Reply #5 on: August 25, 2014, 11:37:37 AM »
...I should max out my 401k to the $17,500 starting next year...

Why wait until next year?  You could start today - ok, as soon as your HR department can update your request.

Jessa

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Re: 401k vs after tax savings?
« Reply #6 on: August 25, 2014, 11:44:48 AM »
...I should max out my 401k to the $17,500 starting next year...

Why wait until next year?  You could start today - ok, as soon as your HR department can update your request.
I can up the amount that I have them take out, but there's no way I can max it out for the year. I was only eligible to contribute at all as of July, I can't make up a full year's worth of deductions and still pay my bills.

MDM

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Re: 401k vs after tax savings?
« Reply #7 on: August 25, 2014, 12:57:28 PM »
I can't make up a full year's worth of deductions and still pay my bills.
Paying one's bills is indeed a good thing to do.

Intent was to stretch your thinking into new perspectives.  Didn't realize you had only started contributing in July so doing all $17,500 in less than 1/2 year could be too far a stretch.

But...what about using the $6K in the CD to pay bills while you tax-defer that much extra into the 401k?  Or, put $5500 of that $6K into a Roth IRA?  Etc., etc. - main thing is to look for ways to avoid or at least defer taxes on as much of your money as possible.

You are doing much better than many already.  Best wishes for more in the future.

Workinghard

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Re: 401k vs after tax savings?
« Reply #8 on: August 25, 2014, 01:37:15 PM »
When I became eligible for my 401k, mid year, I started working OT. I wanted to max out and still keep up with our after-tax contributions. And then I found out they allowed catch-up contributions. Talk about a stretch. I decided to suck it up until the end of the year though. 

TomTX

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Re: 401k vs after tax savings?
« Reply #9 on: August 25, 2014, 08:37:57 PM »
Current Assets:
$57k in a previous company's 401k
$1.3k in current company's 401k
$3k in after tax investments
$6k in a CD that matures this month that I'm planning to invest in mutual funds
$6k in emergeny savings.

Okay, what total expenses are you paying on that old 401(k)? Ditto on the new 401(k)

If you have a very low expense in the new 401(k), consider rolling it all into the new 401(k) - otherwise, consider rolling it into an IRA at Vanguard (call Vanguard Concierge Services, with a 401(k) statement at hand - they are nice, and knowledgeable) If you have low-tax years, you can think about starting a Roth pipeline.

The next question is what you have it invested IN? 401(k) is just an invisible tax shield for the money. What's the investment profile?

As others have mentioned - why $3k in after-tax? Why not put it in a Roth, or use it for living expenses while you put more in the new 401(k)? ditto the CD.

Jessa

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Re: 401k vs after tax savings?
« Reply #10 on: August 26, 2014, 06:43:48 PM »
The old 401k is with Vanguard. I called them to ask if I should roll it into a Vanguard IRA, she said it was fine where it was, the only reason to roll it would be for the broader selection of funds. I currently have a little over 1/3 in the Vanguard Target Retirement 2045 fund, 1/3 in VFINX, and a little over 1/4 in the Lifestrategy Growth fund.

The new 401k is with John Hancock. I have 75% going to the 2050 Active Strategy and 25% to the JH Disciplined Value fund. Since the expense ratios are higher with JH, I figured I'd just leave the old one at Vanguard.

I talked with HR yesterday, I can only change my contribution amounts at the start of the quarter, so I'm stuck at 20% until October 1. I'm thinking I will up it to $673.08 then, so I'll be set to max it out for next year. I may up it more than that for the end of the year, but my SO lost his job last week, so I'm a little hesitant about locking up too much until he gets a new job.

The after tax is partly because I had it sitting in a CD, and it seemed better to invest it than to dink along with my .4%. I was also thinking it would be my seed money to carry me through from when I retire to when I can get to my 401k.

Grande

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Re: 401k vs after tax savings?
« Reply #11 on: August 27, 2014, 11:10:17 AM »
Jessa

I know this has been said but you are doing great. Saving as much as you can and trimming spending as much as you can is 90% of it. Turn your back to consumerism.  Take advantage of 401k and Roth plans. After that consider taxable accounts assuming you have a comfortable cash cushion. Also you are wise to think about low expense funds and retirement plans. Keep reading this blog and blogs like it. Before you know it you'll have a big balance.

There's a MMM post titled (something like) A Millioniare is made 10 bucks at a time.

The point point is dig for small savings, say $40/month. Then immediately put that to savings. Maybe increase your 401k contributions 1% (about $20/paycheck assuming you are paid biweekly). I know you can only change 401k contributions quarterly but I think you get the point. 10 bucks at a time.
 
As for Roth conversions, Roth ladders, etc you are a long way away from that.  It's a more sophisticated topic.  If you have 15+ years to go you really can't assume that's going to be there when it's time. But it doesn't change the fact your simple goal is to save more and spend less.

One last thing is your Vanguard LifeStrategy and Target Retirement 2045 funds are similar in makeup and function. One might suggest you consider consolidating them. They have essentially the same expense ratio (0.17 vs 0.18%) but the Target 2045 has better historical performance. You could move the the LifeStrategy to Target 2045.

Keep it up.
« Last Edit: August 27, 2014, 11:14:07 AM by Grande »