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I start a new job tomorrow morning. My new employer offers a 401K but no matching. All of the funds available have a *minimum* 3.5% front end load. That just chaps my @#$ to pay a load. My other investments - mutual funds, individual stocks - are doing better than these potential 401K investments minus 3.5%, making them appear on the surface to be the better choice. I know, however, that 401K money has other advantages: decreasing your AGI, untouchable in the case of bankruptcy. My question is should I go ahead and join the 401K for these other benefits, despite poorer performance?
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>>>I start a new job tomorrow morning. My new employer offers a 401K but no
matching. All of the funds available have a *minimum* 3.5% front end
load. That just chaps my @#$ to pay a load. My other investments -
mutual funds, individual stocks - are doing better than these potential
401K investments minus 3.5%, making them appear on the surface to be the
better choice. I know, however, that 401K money has other advantages:
decreasing your AGI, untouchable in the case of bankruptcy. My question
is should I go ahead and join the 401K for these other benefits, despite
poorer performance?<<<

Welcome Kecpa.

You seem to have a handle on things.

Take a look at your options. How much can you put away? Is it more than you can in an IRA or Roth? What are your choices of investments? While the load is unreasonable, the effect of the tax defferal is still pretty good if you have exhausted your alternatives.

You just have to be very good at investing to pay taxes on your gains and still beat a good index fund.

LOL...I am TiggerToo

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<< Take a look at your options. How much can you put away? Is it more than you can in an IRA or Roth? What are your choices of investments? While the load is unreasonable, the effect of the tax defferal is still pretty good if you have exhausted your alternatives. >>

I agree with TiggerToo. I had a similar choice several years ago. When the choice was investing in the 401k vs investing in an after-tax account, I chose the 401k to get the tax deferral.

--Doobie
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Greetings, Kecpa, and welcome.

<<I start a new job tomorrow morning. My new employer offers a 401K but no matching. All of the funds available have a *minimum* 3.5% front end load. That just chaps my @#$ to pay a load. My other investments - mutual funds, individual stocks - are doing better than these potential 401K investments minus 3.5%, making them appear on the surface to be the better choice. I know, however, that 401K money has other advantages: decreasing your AGI, untouchable in the case of bankruptcy. My question is should I go ahead and join the 401K for these other benefits, despite poorer performance?>>

You have to run the numbers to be sure, but on the surface and in the absence of any employer match, it seems you can do better for yourself elsewhere. That's especially true of the first $2K, which IMHO should go to a Roth. Step 4 of our 13 Steps to Foolish Retirement Planning will give you one approach in conducting this analysis. You can find it at

http://www.fool.com/Retirement/Retirement.htm

Regards….Pixy

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Kecpa wrote:
>> I start a new job tomorrow morning. My new employer
>> offers a 401K but no matching. All of the funds
>> available have a *minimum* 3.5% front end load.

TMFPixy wrote:
> You have to run the numbers to be sure, but on the
> surface and in the absence of any employer
> match, it seems you can do better for yourself
> elsewhere.

Actually I strongly disagree with TMFPixy. The 401(k) program is a great way to set aside money without taxes. The max 401(k) contribution this year is $10,000 whereas the max IRA contribution is $2,000. Deducting it right from your paycheck before you even see the money is a great way to save.

These days there aren't a lot of tax breaks available, and setting aside $10K per year (more in the future) and allowing that money to grow without taxes is something that you can't turn down. As you begin to earn more money and get to higher tax brackets, this becomes more and more important. I am going to pay as much in taxes this year as my gross salary my first year out of college :-).

Yes the front-end load on your 401(k) funds definitely sucks, no question about it. The 401(k) companies know they have you over a barrel since you have to go with their investments so they always hit you with fees.

However consider what is happening. You're charged a 3.5% fee *once* when you get into the fund, but the money is likely to stay there for many years -- if you're 30 years old now, it may be there for 40 years. During those 40 years, it will grow without any taxes at all. Over time that 3.5% that you paid at the beginning is going to be less and less significant.

Consider what you'd be up against if you invested the money after taxes. First you'd have to pay 28-35% income tax on the money before investing it, which may make all the rest of your taxes more expensive since your AGI will be higher. Then each year you would add to your AGI through dividends and distributions. Then you'll be hit with taxes *again* for capital gains when you want to cash out of your investments. Your investments would have to return at least 28-35% more *per year* to offset the tax benefits you would be getting with a 401(k). Here you're on the wrong side of the compounding equation.

In short, if you put the money into a decent mutual fund (most of them offer an index fund these days) in the 401(k) program and forget about it, the 3.5% front load will diminish over time.

Also note that if you leave your company, you can take your money out of that 401(k) program and, without penalty, roll it over to a self-directed IRA which you can invest as you choose. I did this a couple of years ago, I combined the 401(k) accounts from three previous jobs and put it into a self-directed IRA brokerage account which I invested in good long-term stocks (FNM and BRKB). A few weeks ago I converted that to a Roth IRA. This account is sizable because I was contributing up to around $8,500-9,500 for those years rather than $2,000 per year for an IRA. I got hit with various fees along the way, but I'm still way ahead of the game. And I'm sitting on some pretty huge capital gains in my investments, of which Uncle Sam won't see a dime :-).

Tiddman
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Kecpa wrote:
>> I start a new job tomorrow morning. My new employer
>> offers a 401K but no matching. All of the funds
>> available have a *minimum* 3.5% front end load.

TMFPixy wrote:
> You have to run the numbers to be sure, but on the
> surface and in the absence of any employer
> match, it seems you can do better for yourself
> elsewhere.

Tiddman wrote:
>>Actually I strongly disagree with TMFPixy. The 401(k) program is a great way to set aside money
without taxes. The max 401(k) contribution this year is $10,000 whereas the max IRA contribution
is $2,000. Deducting it right from your paycheck before you even see the money is a great way to
save.<<

Kecpa, I would have to weigh in on the side of TMFPixy on this one. You really have to run the numbers. Again, I would refer you to Robert Sheard's points on poor performing 401(k) options. As he notes, "...it may not be in your best interest to continue contributing to the plan." Or, in your case...begin contributing to the plan.

His article is at --

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

At my employer, our mutual funds trail S&P Index Funds by 42% over the past 4 years. Clearly it is in my interest to get out of our 401(k) unless an index fund is made an option to us.

mcadoo11
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Tiddman writes in part:

Actually I strongly disagree with TMFPixy. The 401(k) program is a great way to set aside money without taxes. The max 401(k) contribution this year is $10,000 whereas the max IRA contribution is $2,000. Deducting it right from your paycheck before you even see the money is a great way to save.

These days there aren't a lot of tax breaks available, and setting aside $10K per year (more in the future) and allowing that money to grow without taxes is something that you can't turn down. As you begin to earn more money and get to higher tax brackets, this becomes more and more important. I am going to pay as much in taxes this year as my gross salary my first year out of college :-).


Don't get blinded by the tax deferral. Not only can you turn down the 401k, you should turn it down when better taxable alternatives are available. If you have the same dedication to an after-tax program as that enforced by a 401k (i.e., automatic contributions that increase at the same time and same rate as your pay), then only an idiot would remain in a 401k that would result in far less money in retirement after taxes than could be had in a taxable investment. To see what I'm talking about, see Step 4 of my 13 Steps to Foolish Retirement Planning available at: http://www.fool.com/Retirement/Retirement.htm .

However consider what is happening. You're charged a 3.5% fee *once* when you get into the fund, but the money is likely to stay there for many years -- if you're 30 years old now, it may be there for 40 years. During those 40 years, it will grow without any taxes at all. Over time that 3.5% that you paid at the beginning is going to be less and less significant.

That's pure poppyrot! That load will be charged on every deposit and on all reinvested earnings, which means that 8% return has an effective rate of about 7.22%. That means $100 per month invested for 30 years (or 360 months) would grow to $128,194. The same $100 invested with no load at 8% becomes $150,030, or some 14.6% more. Somehow, I don't find that "less and less significant. And the larger the contribution, the greater the difference. "Less and less significant" indeed!

Consider what you'd be up against if you invested the money after taxes. First you'd have to pay 28-35% income tax on the money before investing it, which may make all the rest of your taxes more expensive since your AGI will be higher. Then each year you would add to your AGI through dividends and distributions. Then you'll be hit with taxes *again* for capital gains when you want to cash out of your investments. Your investments would have to return at least 28-35% more *per year* to offset the tax benefits you would be getting with a 401(k). Here you're on the wrong side of the compounding equation.

Not necessarily provided you pay attention to the impact of taxes. That's precisely what the formula in Step 4 is designed to do. It's not hard to offset the tax deferral with a 7.22% effective return. For someone in a 28% marginal bracket, an investment earning better than 10.02% will do the trick. And that assumes capital gains will be taxed at 28%, which they won't be.

In short, if you put the money into a decent mutual fund (most of them offer an index fund these days) in the 401(k) program and forget about it, the 3.5% front load will diminish over time.

I don't know where you get your info, but the Department of Labor, the Employee Benefits Research Institute and many others report that over half of the 401k plans available do not offer an index fund. If they did, we wouldn't have this discussion so often.

Also note that if you leave your company, you can take your money out of that 401(k) program and, without penalty, roll it over to a self-directed IRA which you can invest as you choose. I did this a couple of years ago, I combined the 401(k) accounts from three previous jobs and put it into a self-directed IRA brokerage account which I invested in good long-term stocks (FNM and BRKB). A few weeks ago I converted that to a Roth IRA. This account is sizable because I was contributing up to around $8,500-9,500 for those years rather than $2,000 per year for an IRA. I got hit with various fees along the way, but I'm still way ahead of the game. And I'm sitting on some pretty huge capital gains in my investments, of which Uncle Sam won't see a dime :-).

Very true, and it worked fine with you. But I'll still repeat: Sometimes investing in a 401k simply does not make sense despite the tax break. You've got to run the numbers to be sure, but the Foolish approach may very well be the taxable alternative plus a Roth IRA.

Disagree with me if you must…..Just don't let taxes rule what you do so that you become blinded about what may be best for you. Sometimes it's not all that apparent.

Regards…..Pixy


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