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Author: objviv Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75824  
Subject: 401(k), employer match and IRA debate Date: 1/3/2001 9:23 PM
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**Warning long post**

Greetings folks,

To add fuel to the 401(k) employer match vs. IRA debate, please allow me to put forth a situation.

1) John Doe is single and works for this company, which incredibly enough does NOT contribute any match to the 401(k).
2) John's cash compensation including bonuses etc. was $70k last year.
3) John did not participate in company 401(k), but instead put $2000 in an IRA, (not Roth) with a brokerage for the last several years.
4) John Doe's uncle died and left him an annuity of $20,000. Thus, he now expects to earn at least $90,000 this year.
5) This puts John Doe in a higher tax bracket, correct?
6) Not only that, he feels it is better for him to convert his IRA to a Roth, the sooner the better, and now he also has the means to pay the taxes on the conversion. Note that his AGI is less than $100,000.
7) His IRA is worth $20k plus right now.

Now, lets look at 3 scenarios. If you guys can come up with more, please do.

a) He continues not to participate in company 401(k) this year as well, converts his IRA to a Roth, and puts $2000 into his Roth IRA; he must pay taxes on all $110,000.

b) He continues not to participate in company 401(k), converts his current IRA to Roth, invests $2000 into a traditional IRA; his taxable income is $108,000.

In both, a and b, let us also assume that he rigorously invests $10,500 via a separate brokerage account. That's after tax money, still subject to Cap Gains.

c) He converts his IRA to a Roth, but starts participating in 401(k). Of course, the IRA investment is now not deductible, so he may as well put it into a Roth. But his taxable income now reduces to $99,500.

What is John Doe to do, in order to maximize returns, at the lowest possible taxation, now and in the future?

objviv



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Author: tsouth Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 26960 of 75824
Subject: Re: 401(k), employer match and IRA debate Date: 1/4/2001 8:48 AM
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John Doe appears to like paperwork. If John had a hypothetical wife named Jane who, like me, hates paperwork, I believe this is what she would recommend:

1) Keep the Traditional IRA money where it is.

2) Contribute maximum allowed to 401k for immediate tax savings, assume 15% max. contribution.

3) Open a Roth IRA in the new year and contribute $2000 annually.

In this case, John would have $79,500 of taxable income (assuming only job income & the annuity, no other sources of income).

John would still have the $20,000 tax-deferred in the Traditional IRA, would be contributing $10,500 annually into the tax-deferred 401k, and would also be contributing $2000 into the tax-benefitted Roth IRA.

And, John would only have had to fill out the paperwork to open a 401k and the Roth IRA. Much less of a headache.

Best of Luck,

Teresa

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Author: tsouth Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 26964 of 75824
Subject: Re: 401(k), employer match and IRA debate Date: 1/4/2001 9:28 AM
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In this case, John would have $79,500 of taxable income (assuming only job income & the annuity, no other sources of income).

................

Sorry, that should be $79,500 of Adjusted Gross Income (assuming only job income & the annuity, no other sources of income), not taxable income.

Teresa

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Author: objviv Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 26965 of 75824
Subject: Re: 401(k), employer match and IRA debate Date: 1/4/2001 10:15 AM
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Ah, but the 401(k) has no employer match, nada, zilch! No free money, and options for investing are expensive mutual funds only!

In this case, while taxes are saved, he must compromise on long term returns!

Less paper-work, less taxes, and less returns!

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Author: objviv Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 26966 of 75824
Subject: Re: 401(k), employer match and IRA debate Date: 1/4/2001 10:19 AM
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>>John would still have the $20,000 tax-deferred in
>>the Traditional IRA, would be contributing $10,500
>>annually into the tax-deferred 401k, and would also
>>be contributing $2000 into the tax-benefitted Roth
>>IRA.


Not to forget as well, that John Doe is a Fool, and has already decided converting to a Roth is a good thing for him! The money left over from the annuity will pay for the taxes, you see.

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