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401k Strategies


MG2014
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Hi all

 

A lot of you expect to do better than the market over the span of your careers thru your personal investments, and can at the same time afford to contribute up to the 401k max limit of 17500. Do you choose to contribute the max to get the tax break but settle for market returns in your 401k account (due to the limited funds to choose from) or do you choose to contribute only up to your employer match, take the tax hit on the remainder, and expect to do better than the market+tax_hit if you invest the remainder in your personal taxable account?

 

In my example, if I expect my 401k to make 7%, I would personally need to get 12%, assuming a capital gains tax of 18% every year, for my personal investments to start surpassing my 401k (making 7% pre-tax) after 20 years.

 

This is assuming I'll stay with my employer forever and not have the option to roll it over into another IRA. My employer also doesn't allow in-service rollovers or a brokerage window option.

 

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The 401k is great, the match is a 100% return on whatever you put in, plus the tax break.

 

Say you make $100k and put in 10%, and also get a 3% match.  You contribute $10,000 and get $3,000, that's a 30% return right away.  You might consider this part of your compensation, but I'd be willing to bet most of your co-workers aren't taking advantage.  So it's not a guaranteed compensation like a salary.  I look at my employer match as a return on my investment.  I have to do something, actually invest the most, and then I get this guaranteed return, the match.

 

I keep almost my entire 401k in cash and bonds and index funds.  I look at my employer match as a return on my investment, and for what I put in I get about a 20% return on my investment, plus whatever I make in the fund.  I don't plan on working at this company forever, and would prefer to withdrawal my money intact verses a diminished amount in a market drawdown.

 

There are people on here who have brokerage windows and don't plan on leaving their jobs, and if I were in that situation I'd probably be investing differently as well.

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Oh yea, I definitely take advantage of the employer match, but let's go with your example. You can still contribute 17500-10000=7500 more to the 401k if you want. Do you choose to contribute the the 17500 into the 401k or just the 10k and invest that extra 7500 in your taxable account if you expect to do much better than the market?

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Oh yea, I definitely take advantage of the employer match, but let's go with your example. You can still contribute 17500-10000=7500 more to the 401k if you want. Do you choose to contribute the the 17500 into the 401k or just the 10k and invest that extra 7500 in your taxable account if you expect to do much better than the market?

 

Your financial situation is probably a little different than mine then.  I don't make nearly enough to max out the 401k and IRA's.  I guess if I were in our situation I'd probably make sure to max out the Roth IRA first, then the 401k after the match.

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In general, I would contribute to my 401k up to my employer match. After that I would max out my Roth IRA and then max the rest of the 401k. After those 2 items are maxed, if I qualify for HSA/ want a 529/other tax-advantaged space, I would contribute to these.

 

Only after maxing everything above will I go for a taxable account.

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I contribute as much as I can without going over so that I can be sure to not miss any matching contributions.  I don't want to try to beat a dollar in a tax free account with 70 cents in a taxable account.  No reason to make things difficult.

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I've been wrestling with the idea of just setting mine up like WEB has prescribed for Astrid's testamentary trust (90 S&P; 10% ST bonds).  My 401K is limited to funds; no self-direction.  I just want more justification for why he said the S&P 500, with no allocation to smaller cap stocks or international stocks.  Could be, he prefers large, proven high ROE businesses, or maybe he is just trying to really make it a no-brainer.

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I think it really depends on how valid your assumption that you stay with your employer for life is.  I don't think that is a valid assumption in most cases.

 

For me and my wife I assume I'll be able to roll out of a 401k at some point; I think most people can make this assumption these days.  I would generically allocate funds as follows:

 

1. Capture 401k Match.

2. Contribute HSA - if you can

3. Contribute Roth IRA - if you can

4. Max out remainder of 401k 17.5k limit.

5. Max out remainder of 401k non-deductible EE contribution limit (total limit 52k), converting to roth each year, if the option is available

6. Taxable account.

 

I personally cant do #3 and choose not to do #5 even though I could, because I want more money in taxable account for ease of access. 

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Another complication to the matter is choice of roth vs trad 401k.  For some people this is further complicated because their choice of roth vs trad affects the remaining funds they have available, reducing the ability to contribute to the other accounts.

 

Would you choose ROTH if you were younger and expected your salary to go up a bit? Or if you just had a bad feeling about taxes in the future?

 

This picture makes a good case for ROTH. We're pretty low on the tax curve, historically: http://www.ritholtz.com/blog/wp-content/uploads/2011/04/US-tax-rates.png

 

There was another post where someone would do Traditional 401k, roll it over into a Traditional IRA when they could, and then roll that over into a ROTH IRA as they pleased, which let them control how much taxable income they'd have for that year.

 

 

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Another complication to the matter is choice of roth vs trad 401k.  For some people this is further complicated because their choice of roth vs trad affects the remaining funds they have available, reducing the ability to contribute to the other accounts.

 

Would you choose ROTH if you were younger and expected your salary to go up a bit? Or if you just had a bad feeling about taxes in the future?

 

This picture makes a good case for ROTH. We're pretty low on the tax curve, historically: http://www.ritholtz.com/blog/wp-content/uploads/2011/04/US-tax-rates.png

 

There was another post where someone would do Traditional 401k, roll it over into a Traditional IRA when they could, and then roll that over into a ROTH IRA as they pleased, which let them control how much taxable income they'd have for that year.

 

Nah, I prefer to defer unless you're in a really low bracket.  You can always convert to roth at the time of your choosing and in the marginal amount of your choosing via the rack door roth.  Also you can control state taxes with ease.  Why pay today what you can put off until tomorrow?

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Depends upon your 401k options, MG.

 

From good to bad (and high to low cost):

 

1. brokerage window

2. sector indices (Small Value/Emerging Markets/Commodities, High-Yield, etc.)

3. market indices (Total Stock Market/International Stock Market/Total Bond Market)

4. actively managed funds

 

If you've bad options (high cost, actively managed funds), I'd not contribute beyond the employer match.

 

I'd otherwise contribute to the maximum (17,500 plus after-tax, if possible).

 

Edited to add: Should remember the tax-advantaged options in taxable (I- and EE-bonds, MLPs, non-dividend paying individual stocks) when evaluating 401k options.

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I personally cant do #3 and choose not to do #5 even though I could, because I want more money in taxable account for ease of access.

 

Why can you not contribute to a Roth IRA? A "backdoor" contribution allows anyone to contribute.

 

http://online.wsj.com/news/articles/SB10001424052702304104504579375432214126664

 

Interesting. Has anyone tried this successfully?

 

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I personally cant do #3 and choose not to do #5 even though I could, because I want more money in taxable account for ease of access.

 

Why can you not contribute to a Roth IRA? A "backdoor" contribution allows anyone to contribute.

 

http://online.wsj.com/news/articles/SB10001424052702304104504579375432214126664

 

Because that doesn't work if you already have a sizeable traditional IRA Balance.  You have you convert the whole thing then, or take average pro-rata basis.

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Yeah that's my strategy. Good if you are looking to retire early.

 

I think it still depends. 

 

For me, I'll most likely be looking to start my own firm at some point.  My taxable income will likely be lower to start at that point, and hopefully can use this time to convert traditional iras to roth.  2/3 of my current assets are IRAs/HSA.  I've had to weigh the benefit of saving additional money via traditional taxable account in taxable account vs saving in IRA that may have to be withdrawn and/or annuitized before I'm 40 years old.  The scenarios I modeled indicated it would only be slightly more beneficial to put additional money into non-deductible 401, then in-service withdrawal/convert to roth each year.  I thought this would be a great idea at first, but for the work and hassle of having it tied up I concluded it wasn't worth it in my scenario. 

 

 

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I personally cant do #3 and choose not to do #5 even though I could, because I want more money in taxable account for ease of access.

 

Why can you not contribute to a Roth IRA? A "backdoor" contribution allows anyone to contribute.

 

http://online.wsj.com/news/articles/SB10001424052702304104504579375432214126664

 

Interesting. Has anyone tried this successfully?

 

Yes, my wife and I have been doing this for the last few years. However, we don't have any 401K rollovers from previous jobs etc. If you already have a significant balance in your Traditional IRA, it could be an issue ( the link below explains it quite clearly)

 

http://www.forbes.com/sites/josephsteinberg/2012/12/12/warning-about-roth-ira-conversions-often-misunderstood-irs-rule-can-cost-you-money-and-aggravation/

 

 

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