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Author: coolhide Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75340  
Subject: 401K? or On My Own? Date: 10/14/1998 9:49 PM
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I currently started a new job that offers a 401K Plan. The company allows us to contribute 16% of our salary and they match 70% of 6% of what I contribute. So The max I can contribute is $7,000 and they match about $300. The company has a annual rate of return at about 11%. Is it a good idea for me to contribute to this 401K or an I better off investing for my self?
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Author: zgriner Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 6014 of 75340
Subject: Re: 401K? or On My Own? Date: 10/14/1998 10:34 PM
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Your post is unclear. Is your company match invested in company stock and that stock returns 11%? What are your investment options?

Most people would say that you should put at least 6% in your 401k to get the company match. Assuming that you don't qualify for a deductible IRA, you then have three investment options:
1) Put the rest in the 401k.
2) Open a self-directed Roth IRA.
3) Open a regular investment account.

Since the money you are investing is obviously for retirement, #3 is not an option since your investment is not tax-deductible and your returns are taxed.

For #2, the most you can put into a Roth IRA is $2000 for yourself and $2000 for a spouse, working or not. This money is not tax-deductible, but the returns are tax-free if the account is open for 5 years.

For #3, it's easy to invest since it comes out of your paycheck and its done.

Because of the tax-free returns of the Roth IRA, it seems that the best way to invest is to conceptually put 6% (the company match amount) into the 401K, fully fund your Roth IRA and a spousal Roth IRA. Then, if there is any money left over, put it into your 401k.

Zev

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Author: DownwardSpiral One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 6017 of 75340
Subject: Re: 401K? or On My Own? Date: 10/15/1998 8:39 AM
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From the numbers you have given, I calculate that 70% of 6% of your salary is $1800 in company match money, not the $300 you stated.

The general rule on this board is to get the "free" money. Remember, that this is a 70% return on your invested funds, which are also sheltered from immediate taxation.

If your only option is company stock, one must be concerned that over the long run your investment in company stock does not become the major allocation of all your retirement funds. In a downturn at your company, you could face a multiple whammy: Bad and changing conditions at your company, rapid decline of the price of company stock and the value of your retirement account, and possible loss of your job.

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Author: Tiddman Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 6018 of 75340
Subject: Re: 401K? or On My Own? Date: 10/15/1998 8:49 AM
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> I currently started a new job that offers a 401K
> Plan. The company allows us to contribute 16% of our
> salary and they match 70% of 6% of what I contribute.
> So The max I can contribute is $7,000 and they match
> about $300. The company has a annual rate of return
> at about 11%. Is it a good idea for me to contribute
> to this 401K or an I better off investing for my
> self?

In general I think 401(k) programs are a great way to save for retirement. There's no other investment vehicle that allows you to set aside as much money before taxes. And any employer match at all is free money -- in your case, a guaranteed, instantaneous 4% return on investment. That is actually not a huge percentage (many programs match 20-50% of the contributed amount), but hey free money is free money.

The question then is what rate of return you can expect on your invested money. If you really are locked into about 11% then that isn't particularly great. Over the past 70 years that is roughly the stock market average, but over the past 20 or 10 years it is much lower. So you might get better returns by investing the money in the post-tax investments of your choice.

However I wouldn't underestimate the tax savings that the 401(k) program offers you. I don't know how many years you have to go before retirement, but if you are planning on having your salary increase over time, the amount of money you pay in taxes will be more and more important. For example if you're only paying 28% in taxes these days then the tax break of the 401(k) may not seem so great, but when you're up in the 34-37% tax brackets it will be a lot more significant.

I would consider this carefully before turning away from a 401(k) program, possibly including talking to a tax advisor.

Tiddman



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Author: mcadoo11 One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 6024 of 75340
Subject: Re: 401K? or On My Own? Date: 10/15/1998 12:22 PM
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Calculate it yourself and figure out what you should do. Read the following as well:

http://www.fool.com/DDow/1998/DDow980819.htm

mcadoo11

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Author: Tiddman Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 6025 of 75340
Subject: Re: 401K? or On My Own? Date: 10/15/1998 1:01 PM
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> Calculate it yourself and figure out what you should
> do. Read the following as well:
>
> http://www.fool.com/DDow/1998/DDow980819.htm
>
> mcadoo11

The approach suggested in this article depends on the fact that you would be able to achieve at 26% annualized rate of return on your money for the next 15 years.

This is a really tall order! I'm not aware of any investment vehicle that has ever achived this. Even Warren Buffett has achieved "only" 24% annualized and he is one of the most successful investors ever.

Before you pull your money out of your 401(k) and think that you can make a lot more money investing it on your own, I think you need to seriously consider if you can count on the rates of return you will need to pull this off. Rememebr that we're in the best bull market in history and those of us that were not investing 10 years ago know that the recent rates of return are very unusual.

Tiddman


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Author: mcadoo11 One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 6028 of 75340
Subject: Re: 401K? or On My Own? Date: 10/15/1998 4:31 PM
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Tiddman wrote:
Before you pull your money out of your 401(k) and think that you can make a lot more money investing it on your own, I think you need to seriously consider if you can count on the rates of return you will need to pull this off. Rememebr that we're in the best bull market in history and those of us that were not investing 10 years ago know that the recent rates of return are very unusual.


My reply:
Good point. However, if your 401(k) plan has no index options and has mutual funds that are performing rather poorly, it makes all the sense in the world to pull your money out. At my place of work, our 403(b) selections are have performed 42% behind the S&P over the past 3 years and 9 months. I don't anticipate being able to get 24% annualized returns in my IRA, but I do think I can do better than our 403(b) funds with a mix of an index fund, RP investments and Cash-Kings. That may be the case for this person as well.

Again, you should run the numbers yourself. It really depends on the options made available to you through your 401(k).

Also, aren't you taxed when you pull your money out of a 401(k) on the backend as opposed to a Roth IRA? That is something to also consider.

mcadoo11

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Author: Tiddman Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 6029 of 75340
Subject: Re: 401K? or On My Own? Date: 10/15/1998 5:46 PM
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> However, if your 401(k) plan has no index options
> and has mutual funds that are performing rather
> poorly, it makes all the sense in the world to pull
> your money out.

I ran some numbers. Say that you are contributing $5,000 a year. Plan A is the 401(k) program where the contribution is pre-tax money and you pay no taxes until you retire, at which point your tax burden is 15% (your income tax rate at retirement age). Plan B is a post-tax investment account where the contributions are taxed at 31% (your income tax rate) and you need to pay 20% capital gains taxes at retirement.

If Plan B returns 17% annualized (which is rate for the past 13 years) for the next 15 years, and Plan A returns 12.25% (a lame mutual fund rate) for the next 15 years, you'll come out even -- meaning that the amount of money you have at retirement after taxes will be the same. Put another way, your taxable returns have to be 39% better annualized than your 401(k) returns for you to break even. Note that the 39% figure will change as you change any of the above numbers (tax rate, contribution amount, etc) so it is only a single data point.

You said that your company's 401(k) funds have underperformed the market by 42% for the past 3 yrs. 9 mos. I don't know if that is annualized, but if it is, you would be only a little bit ahead by investing the money yourself in a taxable account.

By switching to a taxable account you would lose the benefit of reducing your taxable income by the amount you contribute ($5K/yr in this example) which would increase your taxable income. However you would gain the benefit of the money being fully accessible to you without penalties.

> Also, aren't you taxed when you pull your money out
> of a 401(k) on the backend as opposed to a Roth IRA?

Yep, the Roth IRA is tax exempt rather than tax deferred, which means you'll never be taxed on the money once it's in there. However you can only contribute $2K/yr to it.

Coming up with a Plan C where you contribute $3K to a taxable account and $2K to a Roth IRA account every year is left as an exercise to the reader :-). But I think the only tax advantage is that you won't pay the 20% capital gains at retirement for 2/5ths of the money.

Tiddman


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Author: doctorG Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 6031 of 75340
Subject: Re: 401K? or On My Own? Date: 10/15/1998 6:51 PM
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I had the same questions about my 403b. There's a good article in the archives at

www.fool.com/ddow/1998/ddow980721.htm

I found the calculations helpful. Some of the same issues are also addressed in answers to my query of "to 403b or not to 403b" If you come to any good insights, please share them!

Scott.

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Author: mcadoo11 One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 6043 of 75340
Subject: Re: 401K? or On My Own? Date: 10/16/1998 11:38 AM
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Tiddman, you wrote:
I ran some numbers. Say that you are contributing $5,000 a year. Plan A is the 401(k) program where the contribution is pre-tax money and you pay no taxes until you retire, at which point your tax burden is 15% (your income tax rate at retirement age). Plan B is a post-tax investment account where the contributions are taxed at 31% (your income tax rate) and you need to pay 20% capital gains taxes at retirement.

If Plan B returns 17% annualized (which is rate for the past 13 years) for the next 15 years, and Plan A returns 12.25% (a lame mutual fund rate) for the next 15 years, you'll come out even -- meaning that the amount of money you have at retirement after taxes will be the same. Put another way, your taxable returns have to be 39% better annualized than your 401(k) returns for you to break even. Note that the 39% figure will change as you change any of the above numbers (tax
rate, contribution amount, etc) so it is only a single data point.


There is one major problem with your analysis. First, it would be ridiculous in the latter years to bypass the 401(k) plan for a front-end taxed IRA. For example, in the year prior to retirement, you would almost have to have a return of 50% to make it worthwhile to opt-out. I do not think "doctorG" was considering retiring next year. DoctorG, if you are, Tiddman is right...stay in your 401(k) -- no matter how bad the returns. His analysis certainly bears that out.

However, if you are 15 years away from retirement, under Tiddman's scenario, the returns for Plan B first year $5000 investment would come out 23.8% better than under Plan A. You don't break even...you come out ahead by 23.8%!

That is what I was seeing with our terrible 403(b) -- its lack of an index fund option, terrible returns, and annual expenses of approximately 3% -- so I have now opted out.

For those with better 401(k) options, by all means, stay in and be very happy and grateful. There are some of us out here in 403(b) hell.

Two good articles by Robert Sheard to read on how to calculate which options are best for you are (thanks to "doctorG" himself for one of those references):

http://www.fool.com/ddow/1998/ddow980721.htm
http://www.fool.com/DDow/1998/DDow980819.htm

Another good article about poor performing 403(b) plans is at:

http://www.scottburns.com/981004su.htm

He points out how high-cost 403(b) plans may be "costing you a ton of money...and maybe your retirement security." His suggestion is that "it's time to start making noise and demanding better choices."

The Department of Labor has also recently conducted an analysis of 401(k) fees that is available on their website at:

http://www.dol.gov/

Finally, there is also a website that is even more critical of 401(k) plans and their fees. It is at:

http://members.aol.com/scam401k/index.html

Again, the best option is to have a good 401(k) plan. We are working at changing our plan at work to one that has an index fund option such as Vanguard. SmartMoney's website has a pretty good option for you to analyze how well your 401(k) plan stacks up against others.

Another option is to see if your plan will allow you to roll funds out periodically. That might be a great option (because you could rollover into a self-directed IRA and invest in RP, Foolish 4, Spark5, etc.) except my current mutual fund options have tremendous backload expenses as well. Oh well...

Stuck in 403(b) hell,
mcadoo11


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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 6053 of 75340
Subject: Re: 401K? or On My Own? Date: 10/16/1998 5:11 PM
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Greetings, Coolhide, and welcome. You asked:

I currently started a new job that offers a 401K Plan. The company allows us to contribute 16% of our salary and they match 70% of 6% of what I contribute. So The max I can contribute is $7,000 and they match about $300. The company has a annual rate of return at about 11%. Is it a good idea for me to contribute to this 401K or an I better off investing for my self?

Somehow I think you've misunderstood your plan. At least I certainly hope so, because $300 per year just isn't a great match. I'll bet if you check, you'll see that your employer will match 70 cents on the dollar up to 6% of your pay if you contribute that much. In other words, if you put in 6% the company will match it with 4.2%. If that's the case, then you definitely want to contribute at least that 6% before you turn to anything else.

You don't talk about the options that are available in your plan. What's returning 11% -- company stock, an index fund or something else? Is an index fund one of your choices? Over the long haul, 11% within a 401k is not a bad return, but it is compared to the last three years or so. Can you do better outside the plan? Possibly, depending on the alternatives you pick. Beyond the 6% to the 401k, you may want to put the next $2K in a Roth IRA. While that will be an after-tax contribution, the earnings compound tax-deferred and will ultimately come out tax-free. Using an index fund, you will almost certainly do better than your 401k for that money. Also, a taxable account may provide better returns depending on your tax bracket and the choices you make. All you can do is run the numbers to see if it's true in your case. See Step 4 of my 13 Steps to Foolish Retirement Planning at http://www.fool.com/retirement for one way to do that analysis.

Regards….Pixy


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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 6057 of 75340
Subject: Re: 401K? or On My Own? Date: 10/16/1998 5:16 PM
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Tiddman wrote in part:

I ran some numbers. Say that you are contributing $5,000 a year. Plan A is the 401(k) program where the contribution is pre-tax money and you pay no taxes until you retire, at which point your tax burden is 15% (your income tax rate at retirement age). Plan B is a post-tax investment account where the contributions are taxed at 31% (your income tax rate) and you need to pay 20% capital gains taxes at retirement.

Another well-reasoned post from you, but again I have to quibble. It's a myth that folks will retire to a 15% marginal bracket if they are solidly in the 28% or higher brackets prior to retirement. And to say someone in the 31% bracket today will do so is really a stretch. Therefore, while your math may be correct (I didn't check it), I think the case you constructed would have played better if you used a 31% bracket today and a 28% bracket in retirement. That's more believable.

Ah, numbers…..You can torture them until they say precisely what you want them to. :-)

Regards….Pixy


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Author: cvkiekhafer One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 6076 of 75340
Subject: Re: 401K? or On My Own? Date: 10/17/1998 1:17 PM
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<I currently started a new job that offers a 401K Plan. The company allows us to contribute 16% of our salary and they match 70% of 6% of what I contribute. So The max I can contribute is $7,000 and they match about $300. The company has a annual rate of return at about 11%. Is it a good idea for me to contribute to this 401K or an I better off investing for my self?

Somehow I think you've misunderstood your plan. At least I certainly hope so, because $300 per year just isn't a great match. I'll bet if you check, you'll see that your employer will match 70 cents on the dollar up to 6% of your pay if you contribute that much. In other words, if you put in 6% the company will match it with 4.2%. If that's the case, then you definitely want to contribute at least that 6% before you turn to anything else.>

I would agree. With my calculations I would estimate your company would contirbute about $1800.

depending your your investiment vehicles that doesn't look to bad to me.



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