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Author: ctriplett Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76422  
Subject: Why 401(k)? Date: 10/10/1999 8:22 PM
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Hey All - I'd like some help with seemingly contradictory advice re. 401(k)'s.

1. Foolish advice seems to be to save as much as possible in 401(k)'s to take advantage of tax-deferral and company matching contributions.

2. Shouldn't there be a point at which the (greater) return of a taxable investment outweighs the advantage of a tax-deferred one? I think the formula might be something like this?

TR = Marginal tax rate
Ra = Return expected in after-tax investment
Rp = Return expected in tax-deferred investment

Ra = Rp / (1 - TR)

So, if I'm in the 28% tax bracket, and I can expect 11% in my 401(k) index fund (with no matching contributions), the after tax return I would need to get to equal this would be:

Ra = .11 / (1 - .28)

= .11 / .72

= 15.28%

It is entirely possible that I'm missing something here, but it seems to me that:

3. The 18% returns I might expect by investing my retirement savings in an after-tax Fool 4 portfolio alone would far outpace the 11% index-funded-401(k).

4. Very Important Point - my employer's 401(k) DOES NOT Match contributions!

5. My trusty Quicken Financial Planner backs up these results: if I defer 10% annual income to a taxable account, the wife and I will have at retirement $4,449,741, given 18% annual returns, vs. only $1,992,444 in the tax-deferred 401(k) earning 11%.

6. So, am I missing something? Or would it be safe to say that for those of us who do not have the benefit of matching contributions, the 401(k) is an inferior investment vs. other Foolish strategies?

I sure hope TMF Pixy will weigh in on this one!
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