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Author: cherrybomb17 Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75383  
Subject: 401k vs. taxable acct Date: 12/22/2010 4:24 PM
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I need some investment advice. The hub and I recently paid off our house (yay!) leaving us with some extra cash that we'd like to invest towards retirement. The details:

We're both 41.
Combined HHI of $130k pre-tax.
We each have Roth IRAs which we max out.

We each contribute 10% to our respective 401ks. Both are just so-so as far as expense ratios and investment options. Not horrible but not great. His employer matches up to 6%.

Mine is a little weird.

I never know what my employer's match will be until after the year is over. Once it was a 50% match.(For real!) There hasn't been any match at all in a while, though. Also, I know that at least 2 of my co-workers consistently get money back at the end of the year because they have over-contributed. The reason for this is apparently not enough people participate in our company's plan. (Maybe because of the flaky matching pattern ya think?) So I hesitate to put money in that's just going to come back to me and not have done anything for a whole year.

So what do we do with our extra money? Do we divvy it up between our 401ks or do we put it in our taxable account? I just don't know if the tax advantage of the 401k will offset the semi-crappy funds/higher expense ratio/flakiness.

Help me, Fools!
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Author: Watty56 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67907 of 75383
Subject: Re: 401k vs. taxable acct Date: 12/22/2010 4:52 PM
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Often when people have part of their 401k money returned it is because of the "Highly Compensated Employee" 401K rules (google this). As I recall the limit is around $100K but that might vary by 401K plan.

If you make less than that you would not fall under these rules so you would not need to worry about the HCE rules triggering the return of part of your 401K money.

Greg

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Author: aj485 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: 67908 of 75383
Subject: Re: 401k vs. taxable acct Date: 12/22/2010 5:22 PM
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I never know what my employer's match will be until after the year is over. Once it was a 50% match.(For real!) There hasn't been any match at all in a while, though.

Sounds like your employer is doing 'elective' matching, where they don't commit ahead of time.

Also, I know that at least 2 of my co-workers consistently get money back at the end of the year because they have over-contributed. The reason for this is apparently not enough people participate in our company's plan. (Maybe because of the flaky matching pattern ya think?)

It is partially due to the match, or lack thereof. Generally, getting money back 'because of overcontributions' is because the employee is a 'highly compensated employee' and as such, their contribution is limited based on what the non-highly compensated employees actually contribute. (There are lots of rules about calculating this, but you get the general idea....) This limitation can be overcome if the employer does a 'safe harbor' match for all employees. But since your employer is apparently doing 'elective' matching rather than committing to a match percent/amount, highly compensated employees at your company will get hit with this.

A highly compensated employee is currently anyone who makes more than $110k (adjusts in $5k steps for inflation), owns 5% or more of the business, or is one of the top 20% of earners in the company. This Wikipedia article has some more details: http://en.wikipedia.org/wiki/401(k)

So what do we do with our extra money? Do we divvy it up between our 401ks or do we put it in our taxable account? I just don't know if the tax advantage of the 401k will offset the semi-crappy funds/higher expense ratio/flakiness.

Well, at $130k in income, I presume you are in the 25% tax bracket. So, contributing $100 to your 401(k) would be the equivalent to contributing $75 to a taxable account and paying $25 in taxes. So, you are able to invest more in the 401(k) with the same amount of income. However, IF (and that's a big IF) the tax laws when you retire are similar to the tax laws now, capital gains rates are lower than ordinary income rates, so you wouldn't have to pay as much in taxes then. Since my crystal ball is really cloudy on this point, you have to make your own judgement as to how you would be affected.

On the other hand, because trying to predict what tax laws are going to be 30 years in the future is a crapshoot (at best), I subscribe to the theory that it's best to have investments in a variety of different accounts: Taxable, Tax-Free (Roth) and Tax-Deferred (401(k)/Traditional IRA). That way, you can structure your income in retirement to minimize your taxes. It sounds like you have Tax-Free and Tax-Deferred accounts, but don't have Taxable accounts? If so, then starting a taxable account would probably be a good idea.

AJ

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Author: BruceCM Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67909 of 75383
Subject: Re: 401k vs. taxable acct Date: 12/22/2010 5:24 PM
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Just a couple of fine points:
I never know what my employer's match will be until after the year is over
If the employer's contribution to your retirement plan is discretionary...that is, the employer may make a contribution, a partial contribution or no contribution for the year, it then really isn't a match....its the profit sharing part of a Profit Sharing-401(k) tandem plan. A 401(k) match must be announced prior to the start of the plan year and cannot be changed except under certain extenuating cases (as happened to many employers in 2008)

However, non-highly compensated employees may find an additional contribution to their 401(k) plan at the end of the year, due to any of several possible reasons, such as excess salary contributions by highly compensated employees, the past year's plan is found to be 'top heavy' or reallocation of forfeitures (employer contributions to departed employees who were not fully bested in the employer's past contributions). These amounts are usually modest.

As to your friends at work, another way the employer can correct for over contribution by highly compensated employees other than adding more to non-highly compensated employees, is to return the excess contribution to these highly compensated employees.

This is not an issue with non-highly compensated employees salary deferrals, which you would be based on the figures you've shown.

Many workers today are making contributions to taxable accounts, even though it is after tax, as they can fully control their investments and account expenses. And I suspect that after all qualified plans start reporting their expenses, direct and indirect, to employees after July of 2011, there will be more employees considering making after tax contributions to taxable accounts.

BruceM

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Author: cherrybomb17 Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67910 of 75383
Subject: Re: 401k vs. taxable acct Date: 12/22/2010 5:57 PM
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Thanks to all of you for the info. The highly compensated employee thing makes sense--I'll stop feeling bad for those guys that they got money back. :)

AJ, we do have a taxable account set up but haven't put much there. Maybe we'll split the difference and put some money both places.

Thanks again!

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Author: JLC Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67914 of 75383
Subject: Re: 401k vs. taxable acct Date: 12/22/2010 8:58 PM
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I would contribute enough to get the full match and no more. Especially if you're choices aren't great. Think of the match as free money. Anything left over after reaching the match, put in a taxable account.

With your employer being so inconsistant I'd pass and put that money in a taxable account.

JLC

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Author: TwoCybers Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67915 of 75383
Subject: Re: 401k vs. taxable acct Date: 12/22/2010 9:59 PM
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If you choose to start investing regular account keep in mind any income that account generate will be taxable. So you do not want bonds (that pay dividends). You do not want mutual funds that pay dividends. You most of all do not want to be selling investments at a profit - which will be taxable.

Gordon
Atlanta

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Author: reallyalldone Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67917 of 75383
Subject: Re: 401k vs. taxable acct Date: 12/22/2010 11:39 PM
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You most of all do not want to be selling investments at a profit - which will be taxable.

Because it's better to sell at a loss ????

I would say that it's good to be cognizant of the tax ramifications of a taxable account and to manage them but the point of investing is to make a profit.

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Author: BruceCM Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67918 of 75383
Subject: Re: 401k vs. taxable acct Date: 12/23/2010 12:30 AM
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another point concerning taxable accounts.

unlike retirement accounts, taxable accounts are not protected from creditors. so if you wish to build your retirement savings in taxable accounts, you need to make sure you have adequate liability insurance.

BruceM

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Author: DrTarr Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67927 of 75383
Subject: Re: 401k vs. taxable acct Date: 12/23/2010 12:30 PM
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Both are just so-so as far as expense ratios and investment options

one mans so-so is another man's I wish!!

We each contribute 10% to our respective 401ks

I might be inclined to keep the 10% allotment to the company plan. Sounds like not doing so - you are making an investment decision based on the performance of the instrument in the last couple of years. Once it was even 50%. Do you fell it might be there again? Any signs the company is profitable?

Deciding on the taxable account route will have a lot to do with your investing habits. Givin up the tax deferral status can really effect the bottom line even more than a so-so fee/expense ratio. While aj mentions the "tax diversification" if you do chose a taxable account, manage it as such. Which usually equates to buy and hold non-dividend paying equity.

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Author: DrTarr Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67929 of 75383
Subject: Re: 401k vs. taxable acct Date: 12/23/2010 2:27 PM
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http://www.comcast.net/articles/news-general/20101223/US.401...

Companies are restoring the matching benefits!!

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