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Author: nicpottier Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76078  
Subject: My 401K manager's reaction.. Date: 3/29/1999 3:28 PM
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I decided to stop contributing to my 401K after checking the funds performances and seeing none of them have matched the S&P 500 in the past couple years. I sent a quick note to the manager of our account for our 401K telling him that I was ceasing contributions and why, and he replied with the following:

---

Nick,

That would be very foolish.

You are discontinuing investing in a tax sheltered account? Maybe you
outperform the mutual funds (some of the best in the country) by a FACTOR OF
50% (A HUGE FEAT) but you pay no taxes in the 401k until you retire, and you
give back 30 to 50 % of your gains outside the 401k. So what are you really
accomplishing???

---

His only mistake was not capitalizing 'Foolish'..

I'm quite sure I can do 50% better than the mutual funds offered and I'll have the peace of mind of knowing exactly where my money is invested and how.

-Nic
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Author: Leviathan Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9538 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/29/1999 3:53 PM
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<<< I decided to stop contributing to my 401K after checking the funds performances and seeing none of them have matched the S&P 500 in the past couple years. I sent a quick note to the manager of our account for our 401K telling him that I was ceasing contributions and why, and he replied with the following: >>>

I'm not arguing with your logic here, but I would like to suggest an alternate plan for you. Perhaps you could have peppered the account manager with requests for an S&P Index Fund to be added to your choices. Perhaps if you showed some figures on fund performance to your co-workers, they would also support you. It sounds like if you got an index fund option, you would stay in the 401(k). It never hurts to ask!

Leviathan



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Author: nicpottier Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9539 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/29/1999 3:57 PM
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I'm not arguing with your logic here, but I would like to suggest an alternate plan for you. Perhaps
you could have peppered the account manager with requests for an S&P Index Fund to be added
to your choices. Perhaps if you showed some figures on fund performance to your co-workers,
they would also support you. It sounds like if you got an index fund option, you would stay in the
401(k). It never hurts to ask!


Actually, I did ask him about the index fund, and although it's in the works, one won't be available for quite some time (don't know why it takes so long). I also do not get any matching of funds from my employer for this 401K, so that's another strike against it. I've asked him to tell me when the index fund is available.

Most of my co-workers do not invest in the 401k already, though usually for different reasons...

-Nic

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Author: cfofool Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9540 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/29/1999 3:57 PM
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I'm also going to suggest rethinking your decision.

Even if you fail to get an index fund added to your choices, putting money into the 401k is still a good idea. Assuming you won't work for the same employer forever, you will get a chance to roll all of the pre-tax $, along with earnings into a self-directed IRA at some point.

As you've probably already calculated, you are going to need some incredible performance numbers in order to keep up with (even an underperforming) 401k account.

Kevin

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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: 9543 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/29/1999 4:16 PM
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Nic said:

<<Actually, I did ask him about the index fund, and although it's in the works, one won't be available for quite some time (don't know why it takes so long). I also do not get any matching of funds from my employer for this 401K, so that's another strike against it. I've asked him to tell me when the index fund is available. >>

And Kevin responded:

<<As you've probably already calculated, you are going to need some incredible performance numbers in order to keep up with (even an underperforming) 401k account.>>

To which I add my comments to disagree with Kevin. It's really not all that hard to beat a mediocre 401k plan over the long term when there is no employer match. That tax break ain't everything by a long shot, and too many folks get hung up on that issue. Often, you can do better in a nondeductible IRA and/or taxable account. You have to analyze the alternatives against the 401k on a tax-equivalent basis to be sure. And you have to use the same discipline in any alternative as that required by the 401k (i.e., no withdrawals, automatic deposit and automatic increases to savings that occur at the same time and at the same rate as those to your pay). If you have that discipline, then one way to do the analysis is outlined in Step 4 of our 13 Steps to Foolish Retirement Planning available for your reading pleasure at: http://www.fool.com/Retirement/Retirement.htm .

Regards...Pixy



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Author: cfofool Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9544 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/29/1999 4:52 PM
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Pixy,

Thanks for the link. It's much easier to earn an equivalent after-tax yield than I thought. One question, does the amount of outperformance need to increase the longer the compounding period?

Thanks in advance,

Kevin

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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: 9549 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/29/1999 6:37 PM
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Kevin asks:

<<One question, does the amount of outperformance need to increase the longer the compounding period?>>

No, it doesn't. The period isn't important, just the rate.

Regards..Pixy

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Author: tonyw44 Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9558 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/30/1999 1:24 AM
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Actually, you may be making a huge mistake. Does your company provide a match? If so, then you are giving up that match, and you're also giving up the tax benefits of contributing before tax dollars to the 401k.

Think it through first. If there's a match, then you should put in the maximum amount your employer will match. And, if you go after tax, you've got to come up with 40 percent more in order to put the same amount of money to work for you.

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Author: TheBadger Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9563 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/30/1999 9:15 AM
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I have read most of the posts on this question which is essentially: "Should one forego a 401(k) with no match & poor fund selections in favor of a normal after tax account within which one can make equity/fund purchases that beat the 401(k) funds by 50%?"

To answer this question I built some simple Lotus models as follows:

1. Stay in the 401(k) putting in $10k per year & earning 8% for 30 years. Result is $1,178,145 before tax; $789,357 after tax assuming a 28% federal rate and a 5% state rate.

2. Open an after tax account, putting in $6,700 per year (the same $10,000 minus current year federal and state taxes at 28% & 5%), but earning 12% per year (50% better than the 401(k) plan), and also subtracting 20% of the earnings each year (assuming our investor is smart enough to generate all LTCG on the taxable earnings). Result is $1,071,004 after 30 years. Actually this number would be a little smaller if the earnings in the account have some regular income during the years; nonetheless, the after tax account handily beat the 401(k) plan by 35%.

This would suggest that employees should shun a no match / poor fund selection plan in favor of an after tax account as long as they can make investment selections that beat the 401(k) plan by 50% or more. (Actually, the breakeven is around 25%).

Then I tried model #3, within which the employee stays in the 401(k) suffering the poor returns for 10 years. At the end of 10 years, the employee quits & rolls over his 401(k) account to a self-directed IRA (so he can now achieve the 12% per annum return for the next 20 years). Additionally, he goes to work for a new employer that does have a better 401(k) plan that allows him to achieve 12% return on contributions made in years 11 to 30. Results: $2,217,069 before tax; $1,485,436 after tax; 39% better than the after-tax account.

From this model, one could conclude that it is still wise to contribute to a relatively underperforming 401(k) plan for quite a while (10 years in this example) recognizing that the typical employee changes jobs quite frequently in today's job/career marketplace & will have the opportunity to perform a rollover & step up the earnings performance of the 401(k) nest egg in later years. Unfortunately, the only way to create the "deferred nest egg" is for the employee to suffer the pain of 10 years of underperformance.

I could have built models 4,5,& 6, but stopped here to demonstrate that early year poor returns from the 401(k) vs. after-tax self-directed returns can be very decieving. I further suspect that the younger the investor, the more profitable it will be in the end to suffer the 401(k) poor returns during the early years in order to build the "deferred asset" that can be rolled & self-directed for another 10,20,30 years.









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Author: jesther Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9565 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/30/1999 10:31 AM
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Nic,
Although its hard to beat the tax advantage of the
401k, your manager overstates the difficulties. If you
invest on your own and manage your gains, you can
limit the tax liabilites to those of "long term"
capital gains rates. The rate will be significantly
less than the 30-50% stated by your manager. And if
your "long term" is long enough, the income may
wind up being deferred to your retirement years
anyway.
I do agree with another post that it still may be
be better to continue contributing to your current
401k if there is a reasonable likelyhood you may
leave your current employer. Then roll it over to
an IRA of your choice that is more beneficial, perhaps
a self directed stock IRA.

Jesther

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Author: IndecisiveFool Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9566 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/30/1999 10:59 AM
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This thread has generated an interesting number of posts. Step 4 of the Foolish Retirement Planning section has been discussed many times in the past. The equation in Step 4 is used to compare tax-deferred to taxable savings. But the withdrawl of funds is important also. I wonder if TMFPixy in the future will account for the difference in tax rates between taxable and tax-deferred accounts at time of withdrawl.

Also, Badger had an interesting post about investing in poor performing 401k's for people who leave employment after 10 years (as an example) and then rolling that 401k into a self-directed IRA. I know it is hard to account for every situation in Steps to Retirement, but this example seems to modify the Conclusion to Step 4.

It doesn't look like there is any right answer. Maybe the only good solution is to do the calculations yourself.

..IF

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Author: tonyw44 Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9567 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/30/1999 11:17 AM
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Also, I think ten years at one employer is way too optimistic. I have been in the work force for nine years now, and I've had four jobs.



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Author: IndecisiveFool Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9568 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/30/1999 11:54 AM
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Also, I think ten years at one employer is way too optimistic. I have been in the work force for nine years now, and I've had four jobs.

Your answer shows why each person has to do their own calculations. I've been with my same employer 6 years and my wife is on 5 years. There does not seem to be any changes in sight.

..IF

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Author: nicpottier Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9569 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/30/1999 12:08 PM
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1. Stay in the 401(k) putting in $10k per year & earning 8% for 30 years. Result is $1,178,145
before tax; $789,357 after tax assuming a 28% federal rate and a 5% state rate.

2. Open an after tax account, putting in $6,700 per year (the same $10,000 minus current year
federal and state taxes at 28% & 5%), but earning 12% per year (50% better than the 401(k)
plan), and also subtracting 20% of the earnings each year (assuming our investor is smart enough to
generate all LTCG on the taxable earnings). Result is $1,071,004 after 30 years. Actually this
number would be a little smaller if the earnings in the account have some regular income during the
years; nonetheless, the after tax account handily beat the 401(k) plan by 35%.



Then I tried model #3, within which the employee stays in the 401(k) suffering the poor returns for
10 years. At the end of 10 years, the employee quits & rolls over his 401(k) account to a
self-directed IRA (so he can now achieve the 12% per annum return for the next 20 years).
Additionally, he goes to work for a new employer that does have a better 401(k) plan that allows
him to achieve 12% return on contributions made in years 11 to 30. Results: $2,217,069 before
tax; $1,485,436 after tax; 39% better than the after-tax account.


Wow, thanks for that model Badger.. this might very well be the most definitive answer I've seen on this topic yet. The one question I have is whether it is always possible to switch your 401k when leaving your employer to a self directed IRA.. That does sound like the best option for me right now, especially considering I have 40 years of working ahead of me (well, hopefully less with the Fools help). If you don't mind, I'd like to send your message over to my manager to help explain why I might change my mind once again and continue my contributions, in the hope that it will one day be rolled over into a self directed IRA.

Thanks again,

-Nic



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Author: TheBadger Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9570 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/30/1999 12:24 PM
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Several posts have been added after my numerical model results suggesting that each person should mathematically model their own personal results.

I COULD NOT AGREE MORE.

Age, savings habits, risk taking tolerance & related performance returns, (un)likely job turnover, etc. all effect the potential results & can only be properly accounted for by taking a very personal and detailed look at this issue.

At the same time, I ignored (and maybe others) the root isssue --- a shitty 401(k) plan. On the one hand, it is difficult (but not impossible) to talk an employer into a 401(k) matching program, it is much easier to talk an employer into improving the fund selections. It does take some administrative up front work, but after a better set of funds are in place, it is generally no skin of the employer's nose.



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Author: tonyw44 Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9571 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/30/1999 1:21 PM
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I'm a free agent, my friend, and I don't have to worry about playing out the season. If someone comes to me with a better offer and it's a better move for me, I'll take it.

Look, companies aren't going to be loyal to me and they'll lay me off the moment they can't use me anymore. So it's the same way for me. I'll leave them the moment they aren't useful to me anymore.

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Author: scratchi Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9572 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/30/1999 1:29 PM
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Then I tried model #3, within which the employee stays in the 401(k) suffering the poor returns for 10 years. At the end of 10 years, the employee quits & rolls over his 401(k) account to a self-directed IRA (so he can now achieve the 12% per annum return for the next 20 years). Additionally, he goes to work for a new employer that does have a better 401(k) plan that allows him to achieve 12% return on contributions made in years 11 to 30. Results: $2,217,069 before tax; $1,485,436 after tax; 39% better than the after-tax account.

From this model, one could conclude that it is still wise to contribute to a relatively underperforming 401(k) plan for quite a while (10 years in this example) recognizing that the typical employee changes jobs quite frequently in today's job/career marketplace & will have the opportunity to perform a rollover & step up the earnings performance of the 401(k) nest egg in later years. Unfortunately, the only way to create the "deferred nest egg" is for the employee to suffer the pain of 10 years of underperformance.


I ran that analysis on my own just for the heck of it. The variables are: how long until retirement, how long in the 401k, and how long in the IRA; how much matching % you get on how much % of how much money you contribute; what raises (if any) you expect to get during employment (ha!); what performance you can expect from the 401k and from the IRA.

In my case, my total moolah at age 60 peaked if I stay in my current employer's 401k plan for 8 years, then quit, so that I can roll it into an IRA and continue adding $2000 a year from that point on. (I don't know how else to get the money rolled out of a 401k, unless you quit or get fired or the plan itself terminates.)

Don't tell the boss!

The alternatives were: staying in the 401k until age 60; or doing just a Roth IRA from right now until age 60. (But I'm also doing a Roth anyway besides the 401k.)



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Author: TrevorHicks Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9573 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/30/1999 4:19 PM
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I'm a free agent, my friend, and I don't have to worry about playing out the season. If someone
comes to me with a better offer and it's a better move for me, I'll take it.

Look, companies aren't going to be loyal to me and they'll lay me off the moment they can't use me
anymore. So it's the same way for me. I'll leave them the moment they aren't useful to me anymore.


I think we're straying a bit from the board topic, but as a recruiting manager in a large corporation, I thought my opinions might be of interest here.

You're certainly right to consider your relationship with your employer to be a business relationship. In a sense, you are a vendor of your labor, whatever your skills may be. As with any vendor relationship, one of the factors we consider when selecting a vendor (employee) is long term reliability. I don't want to have to do a new search for the same position each year. One of the ways we encourage long term reliability in our employees is to provide benefits such as health care, 401k matching, pension, discounted stock purchase, profit sharing, etc. most of which require length of service to participate in or vest in.

Given your past work history, you've shown that you aren't reliable so I wouldn't waste those benefits on you. Someone like yourself would never get anything but short term contract work from me. Loyalty never enters in to it. It's quite true that if you become unprofitable for the company to keep around, you likely won't last long.

I'm not saying you aren't doing what's best for you, just that you should consider how such a resume as yours impacts your future prospects. This may not bother you, but if you keep this up, say if after 12 years you've had 8 jobs, I think you'll find few companies willing to hire you for anything but contract work.

And to bring this back around to retirement investing, most company match programs require that you stick around long enough to be vested, anywhere from 3-7 years. For instance, you have to stick it out 5 years to 100% vest your profit sharing, 401k match and pension with us. And your pension accrual increases by 33% once you hit 15 years. Of course every company has different programs and rules, but you might be surprised at the value of vesting. They may outweigh even a short term 15-20% salary increase. Not to mention the fact that as I mentioned above, your access to these kinds benefits at all may become limited as you job hop.

Cheers,

Trevor

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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: 9577 of 76078
Subject: Re: My 401K manager's reaction.. Date: 3/30/1999 4:57 PM
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IF writes,

<<This thread has generated an interesting number of posts. Step 4 of the Foolish Retirement Planning section has been discussed many times in the past. The equation in Step 4 is used to compare tax-deferred to taxable savings. But the withdrawl of funds is important also. I wonder if TMFPixy in the future will account for the difference in tax rates between taxable and tax-deferred accounts at time of withdrawl.

Also, Badger had an interesting post about investing in poor performing 401k's for people who leave employment after 10 years (as an example) and then rolling that 401k into a self-directed IRA. I know it is hard to account for every situation in Steps to Retirement, but this example seems to modify the Conclusion to Step 4.

It doesn't look like there is any right answer. Maybe the only good solution is to do the calculations yourself.>>


Like the Badger, I agree the only solution is for the person involved to run his/her numbers based on his/her assumptions. All of us can come up with variations that will make one choice better than another, but we're dealing in the abstract. In reality, we will be faced with the here and now. What are the choices in the plan and how do they stack up against our alternatives? How long do we have to invest? In the absence of a match by an employer, I'm personally convinced I'll do better outside of most plans rather than within them. But even that's not always true.

Regards..Pixy


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Author: Rayvt Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9664 of 76078
Subject: Re: My 401K manager's reaction.. Date: 4/4/1999 12:04 AM
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<<To which I add my comments to disagree with Kevin. It's really not all that hard to beat a mediocre 401k plan over the long term when there is no employer match>>

I jump in to concur with Pixy. Except that he should have put the period after the word "plan".

Merely putting your money into SPY would do the trick. Virtually no taxes until you sell (in retirement), and when you do sell you pay capgains tax rate instead of ordinary tax rate.

QQQ is probably even better. The dividends don't cover the management fee, so you don't have to pay annual taxes on the dividends like you do with SPY.

'course, for a long term, XLK (Technology Sector Spyder) would probably be even better.

Ray


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