401K Question...

[58-4ever]

my employer offers matching funds up to 5 percent of my total income. Should I have them do this with pre-tax money or post-tax money?

[chubychecker]

Originally Posted by alnorth

The thing you might be thinking about is the neat little withdrawal provisions for Roths. Unlike traditionals, you can withdraw your contribution (not earnings) penalty-free, with a few restrictions that I forget. (Needs to be in there for X years, or something)

Needs to be in for 5 years. Can only withdraw principal like Al said. still no taxes though, because this is after tax money.

[alnorth]

Originally Posted by chubychecker

I have to disagree with you on this one al. Especially if you are young. A 30 year old will double his contributions likely at least 4 times before they retire. Would you rather pay taxes on $100 now or $1600 later. Even though many of us will be making less money when we are retired, we don't know what the tax brackets of the future will be. Also as al mentioned the IRS doesn't force minimum distributions on the Roth. They are also great for passing on money to heirs. If you were to pass away with a large traditional IRA, your heirs are forced to maintain distributions on that money. Thus uncle sam becomes a partner on their inheritance. The roth passes tax-free.

I admit that the decision to contribute to Roth vs traditional is less cut-and-dried and I should call it my opinion rather than a widely-agreed fact. I can easily think of situations that could theoretically happen in this country over the next few years that would make my recommendation a horrible choice.

I'm using the assumption that even if the left takes over, they will continue to allow brackets to ratchet up every year and will not substantially increase taxes, nor will the GOP be allowed to go wild with tax decreases. If any of that happens, all bets are off and anyone's guess is as good as mine. I could see someone hedging their bets half and half if they are in an iffy situation.

OK, all that aside lets pretend nothing changes, then if your income tax bracket (and how deep you are into your current tax bracket) doesnt change, then its a wash.

Assumptions: earn 7%/year compounded annually, contribute $10,000 per year once per year starting in one year, retire in 30 years, and lets say that every dime of that money is in the 15% bracket. (or 25%, or any bracket, as long as it doesnt change) Lets say the raises you get keep up perfectly with inflation and the increase in tax brackets, so to make the math easy we'll freeze it here.

Roth: 1,500 goes to the govt, you put in 8,500 per year. After 30 years, you have $802,916.68

Traditional: All 10,000 goes into the IRA, after 30 years you have $944,607.86. Assuming every penny gets taxed at 15% in retirement, you send $141,691.18 to uncle sam, and you have $802,916.68

(Obviously you wouldnt pay the tax all at once, but rather gradually over time, but mathematically its still a wash under those assumptions)

Nothing changes, you have the same amount of money either way if your tax liability also does not change.

This is purely a tax decision, if youll retire at a lower income tax bracket which a LOT more people will than think they will due to increasing tax brackets every year, then go traditional. If youll retire in a higher tax bracket, go Roth. You can also throw politics if you want. If you think our tax policy will become worse for you because of the politicians in power and all else is equal, pay the tax now. If you think youll have more breaks or a lower rate later pay it later.

For me, I'm in a rather high bracket and think the tax laws arent going to change much since they still need to get re-elected every year, so I'm going traditional until maxed out, then Roth, but other people's situation could be different.

If I thought it was truely a tie (my tax liability wont change now to retirement), I'd probably emphasise Roth due to the neat little perks they have. I dont plan on leaving anything to anyone, if I have a huge retirement account when I retire, its time to spend that money down before I croak If someone wants to leave an inheritance, then a Roth is better to inherit.

[Moooo]

Originally Posted by chubychecker

Nope you're incorrect. The money is 100% tax-free. Principal and interest. This is why the roth is sooooooo attractive.

It sounds like a 50/50 choice. I could be wrong but it seems the main factor is the taxation at time of deposit and withdrawl. It really doesn't have to do with numbers as much as percentages...

Moooo

[chubychecker]

Originally Posted by Moooo

It sounds like a 50/50 choice. I could be wrong but it seems the main factor is the taxation at time of deposit and withdrawl. It really doesn't have to do with numbers as much as percentages...

Moooo

Bingo; like I said earlier that's why I split it up half and half. Most plans that have a roth option now allow you to do that.

[Logical]

Originally Posted by chubychecker

There are a few things to clear up.
1. There is no income limit for the Roth 401k. This is not like the roth Ira where there is a maximum income limit.
2. In 2010 a conversion is available to everyone. Currently you can only convert if you meet certain income limitations. However, the conversion amount is still taxable at your income tax rate. You can spread this out over 2 years though if I'm not mistaken.
3. Real estate; although a good investment does not have anywhere close to the long term performance of the stock market. Over the last 30 years Real-estate has returned a little less than 5% a year compared to almost 13% for the S%P. Real estate is a very trendy investment right now; much like technology was 6-7 years ago. Watch out.
4. Roth IRA's 401k's are great investments. I have to disagree with you on this one al. Especially if you are young. A 30 year old will double his contributions likely at least 4 times before they retire. Would you rather pay taxes on $100 now or $1600 later. Even though many of us will be making less money when we are retired, we don't know what the tax brackets of the future will be. Also as al mentioned the IRS doesn't force minimum distributions on the Roth. They are also great for passing on money to heirs. If you were to pass away with a large traditional IRA, your heirs are forced to maintain distributions on that money. Thus uncle sam becomes a partner on their inheritance. The roth passes tax-free.

401k's are great investments, if you believe otherwise it is simply because you are uneducated of the great benefits.

Be safe; and don't put all your eggs in one basket.

I thought there was a limit to how much a company could match? I seem to recall it being around 16K has that changed?

[alnorth]

Originally Posted by Logical

I thought there was a limit to how much a company could match? I seem to recall it being around 16K has that changed?

Hmm... dont know if there is a limit, but I wouldnt be surprised.

If not, youd be unofficially capped on that match anyway. A really generous match would match up to 6% of salary. If 6% is 16k, your salary would be almost $270,000. Most senior managers and executives making that kind of money routinely get love letters from the IRS saying that they are classified as a "Highly Compensated Employee", and thus are only allowed to contribute a smaller amount well under the federal limits, so their match also goes down.

[Moooo]

Originally Posted by alnorth

Hmm... dont know if there is a limit, but I wouldnt be surprised.

If not, youd be unofficially capped on that match anyway. A really generous match would match up to 6% of salary. If 6% is 16k, your salary would be almost $270,000. Most senior managers and executives making that kind of money routinely get love letters from the IRS saying that they are classified as a "Highly Compensated Employee", and thus are only allowed to contribute a smaller amount well under the federal limits, so their match also goes down.

So if you make a lot you aren't AS eligible as if you were making a lower income... interesting...

I'm still trying to learn the differences between the IRA and 401k after the employer stops matching or if they don't (as in luv's case).

Moooo

[luv]

Originally Posted by Moooo

So if you make a lot you aren't AS eligible as if you were making a lower income... interesting...

I'm still trying to learn the differences between the IRA and 401k after the employer stops matching or if they don't (as in luv's case).

Moooo

One difference would be that my contributions are deducted from my paycheck before taxes are taken out. I think I would have to put money into an IRA myself. I'm probably wrong on that. I'm not sure. I'm limited on what I can do with my 401k based upon option that my employer chooses. Like, right now, I can no longer borrow against my 401k.

[alnorth]

Originally Posted by luv

One difference would be that my contributions are deducted from my paycheck before taxes are taken out. I think I would have to put money into an IRA myself. I'm probably wrong on that. I'm not sure. I'm limited on what I can do with my 401k based upon option that my employer chooses. Like, right now, I can no longer borrow against my 401k.

Yeah, with an IRA you may have to settle with getting a big refund check in April, unless your employer is cool enough to let you reduce your withholding if you anticipate an IRA deduction.

The biggest difference which causes many people to settle with a 401k even though the options are more limited, is your allowed to contribute a LOT more money into the 401k (assuming your not a highly compensated employee). I think you can only put 4 or 5 thousand into an IRA every year, while you can put in 15,000 into a 401k, or 20,000 over age 50.

You can not put money into a 401k and an IRA in the same year. (rollovers dont count, you can have both if you quit, roll the old 401k into an IRA, get another job, and start funding the new 401k. The IRA is still sitting there earning money with what you put or rolled into it).

However, to make it more confusing, if you dont earn a ton of money, most people can put money into a Roth IRA and a traditional 401k at the same time. So sometimes if your in a really high income tax bracket you may max out the 401k first, and then your shut off from pre-tax vehicles, all you got left is maybe a Roth IRA. Well its better than investing it personally in your own private account with no favorable tax treatment, so at that point you might as well fund the Roth IRA too.

[alnorth]

This all assumes your an employee. If you have a successful small business with no employees, wow there are a hell of a lot of choices for you if you incorporate as an S corp. Simple IRA's, your own 401 (uni-k's), dividends taxed at capital gain rates, defined benefit pension plans, etc. If you fall in that blessed category, you need a very good CPA and maybe a tax/pension lawyer.

[Halfcan]

Originally Posted by jspchief

That's ridiculous. You must be in the worst 401k program in the universe if you're paying so many fees that the match is negated. 100% match of 5% is a lot of free money before the money even gets put to work through investments.

401ks are great investments for the average Joe. For starters, your contribution gets taken before you ever see the check, eliminating the discipline hurdle that most people can't get over. Second, most are run through comapnies that are experts at picking funds, eliminating the stock market ignorance that the average person faces.

As for real estate, sure it's a great investment if you have a pile of cash sitting around. But taking $50 per week from your paycheck is going to take a hella long time to get enough to invest in real estate. Time that your money could have spent earning more.

Telling a young person that doesn't even understand a 401k to invest in real estate instead might be the worst advice ever given on this website.

Telling a young person to buy their own home instead of rent is bad advice??

So he puts his $50 in a 401k great if that helps him save. But if that same person is paying $700 a month in rent-what is the point? When you figure in inflation and fees-a majority of 401 ks will not outperform RE.

There is something called leverage-you use other peoples money to secure a property, not only do you get a tax break on the interest, you benefit with appreciation. Instead of rent you are paying down a mortgage that will someday be paid off leaving an asset that will continue to increase.

As for a pile of money-hardly-there are Gov Bond programs and financing options galore-with no money down.

[Rausch]

Originally Posted by alnorth

This all assumes your an employee. If you have a successful small business with no employees, wow there are a hell of a lot of choices for you if you incorporate as an S corp. .

I'm out.

You lost me early on...

[chief52]

Originally Posted by Halfcan

Telling a young person to buy their own home instead of rent is bad advice??

So he puts his $50 in a 401k great if that helps him save. But if that same person is paying $700 a month in rent-what is the point? When you figure in inflation and fees-a majority of 401 ks will not outperform RE.

There is something called leverage-you use other peoples money to secure a property, not only do you get a tax break on the interest, you benefit with appreciation. Instead of rent you are paying down a mortgage that will someday be paid off leaving an asset that will continue to increase.

As for a pile of money-hardly-there are Gov Bond programs and financing options galore-with no money down.

Where are you coming up with this fees crap? They are minimal...or none at all. Also, you are forgetting the company matching.

Most 401k plans have minimal if any fees...get a clue.

[alnorth]

Originally Posted by Halfcan

So he puts his $50 in a 401k great if that helps him save. But if that same person is paying $700 a month in rent-what is the point? When you figure in inflation and fees-a majority of 401 ks will not outperform RE.

There is something called leverage-you use other peoples money to secure a property, not only do you get a tax break on the interest, you benefit with appreciation. Instead of rent you are paying down a mortgage that will someday be paid off leaving an asset that will continue to increase.

Why does it have to be either-or? People dont save enough even counting the mortgage, and putting all your money into a home, spending the rest is not very well diversified and could leave you short in retirement. The capital gains exemption is awesome when you sell for a gain, but what happens if your now living in the next Florida when you need to get money out of the house and your value is stagnating or decreasing? It would be nice to have a huge IRA to supplement your income.

Given that most 401k's have options with microscopic fees, the market has historically returned as well or better than real estate. *Recently* that has not been the case obviously, but the real estate market is cooling down now and will likely enter a period of slow appreciation.

[chief52]

Originally Posted by alnorth

Why does it have to be either-or? People dont save enough even counting the mortgage, and putting all your money into a home, spending the rest is not very well diversified and could leave you short in retirement. The capital gains exemption is awesome when you sell for a gain, but what happens if your now living in the next Florida when you need to get money out of the house and your value is stagnating or decreasing? It would be nice to have a huge IRA to supplement your income.

Given that most 401k's have options with microscopic fees, the market has historically returned as well or better than real estate. *Recently* that has not been the case obviously, but the real estate market is cooling down now and will likely enter a period of slow appreciation.

Very good post. Also, the portion of your 401k that has company matching has definitely done better than the real estate market even in these times. It is hard to put up $1 and have it immediatly matched so you now have $2 anywhere else.