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Hi,

Background:

I am 16ish years from retirement. My employer has recently setup a 401k that I contribute enough to to receive the maximum available employers match. I also max out my Roth and contribute to my own standard taxable accounts. I view these taxable accounts as part of my overall retirement money - not to be spent on 'wants'.

I am trying to decide whether I am better off increasing my 401k contributions (I am currently well under the max allowed) or making these same contributions to a taxable account. I am not sure if I like the idea of contributing more to the 401k. Based on my analysis of our 401k provider I feel the fees are a little high (approx 1.6%/year) and selection of investments is adequate (not great). This leads me to want to put my extra $$ into taxable accounts where I have more choices and possibly smaller fees.

I am having a tough time working through the analysis of which would be smarter. Would the 401k contributions be more valuable because they can grow tax free - even if everything is taxed as regular income when withdrawn? Or should I choose tax friendly after tax vehicles that become long term gains and dividends (both at a smaller rate then my marginal taxes)?

Has anyone done any analysis of which might be a better vehicle to save for the long term?

Thanks for any advices.

Wayne
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… Based on my analysis of our 401k provider I feel the fees are a little high (approx 1.6%/year) and selection of investments is adequate (not great).,..

That is actually pretty high. Look though it again to see if there isn't an index fund buried in it with lower fees. If not I would send a letter or email to the person at you company managing the 401K asking for a low fee index fund. In my 401k there are a number of mediocre funds but they included a few low cost index funds so that the company could claim they provided adequate choices in case the were ever sued over the 401K fund performance(which has happened)

If the best fund choice that you have really does have a 1.6% fee than I would suspect that a spreadsheet would show that you would be better off not contributing any more than the matched amount. The details will vary with your income and your state tax rates so you would really need to do the calculations with your numbers.

Greg
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Generally pretax 401K (taxed at ordinary income tax rates in retirement) is mathematically identical to Roth IRA (after tax, then not taxed in retirement) (when income tax rates are the same now as in retirement). The best you can do in a taxable account is long term buy and hold, which is after tax and when done successfully taxed at capital gains rates.

So clearly pretax 401K is preferable to LTBH investing. Plus the 401K can be rolled over the an IRA and converted to a Roth at some time in the future.

As the previous poster pointed out, a spread sheet will tell you if the fees are prohibitive. But 1.6% is still small compared to the 10 to 11% return you expect to get from an S&P 500 Index fund. Hence, I would be inclined to stick with the 401K at least to the pretax max.
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I would suspect that a spreadsheet would show that you would be better off not contributing any more than the matched amount.

In fact, this spreadsheet :-)

http://www.retireearlyhomepage.com/401ksft.html
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Thanks for the responses. I am already contributing the max to my Roth so I am interested in the comparison of additional moneys to the 401k vs a taxable account. I just want to make sure my quick spreadsheet analysis is sound.

So clearly pretax 401K is preferable to LTBH investing

To test this out is this a reasonable set of facts to use in a spreadsheet to compare:

If I assume (all numbers are assumptions) for one year that I put an additional $5000 in my 401k. That would net me $1250 less in taxes (based on 25% bracket). In two years time this grows by 20% to an account value of $6000. If I were to withdraw this amount of money at the same 25% tax rate I would have taxes of $1500 and a net of $4500.

If I contributed the same NET moneys ($5000-$1250=$3750) to a taxable account and saw the same two year LTBH growth of 20% I would have an account value of $4500 ($3750+$750). If I take all the proceeds the $750 is taxable at long term rates of 15% (tax=$112.50) which nets me $4387.50.

The 401k does seem like the better investment. Unless I am missing something in my thought process.

Is this analysis sound?

Thank you,

Wayne
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The 401k does seem like the better investment. Unless I am missing something in my thought process.

Is this analysis sound?


It is if you don't think you want to do anything with the money before the tax penalty goes away. There's a piece that isn't mathematical in this decision.

rad
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...Unless I am missing something in my thought process. .... taxable account and saw the same two year LTBH growth of 20%...

You are missing the lower fees that you would get in a taxable account. You can easily find an index fund with expenses of less than 0.2% compared to the 1.6% that you said your 401K funds had, so each year your returns will be 1.4% lower in the 401K. It will be skewed slightly with the interest compounds, but the 20% return that you projected in the taxable account would be about 20%-(2*1.4%)= 17.2% in the 401K. This really will add up over a few decades.

Greg
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That' exactly the item I was looking for:

In fact, this spreadsheet :-)

http://www.retireearlyhomepage.com/401ksft.html


Thank you DeltaOne81. It takes the fees into account and definitely shows that extra $$ (above the amount required for an employer match) would be better in a low fee taxable account.

I guess I'll have to find out why the fees are so high. The 401k my employee offers is administered by John Hancock. Does anyone know what might cause the higher fees? How many levels of 'management' are dipping into the oversight (and taking a cut)?

Wayne
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I guess I'll have to find out why the fees are so high.

I would show those results to your co-workers, your boss, etc, and show them that fund companies dips into your pocket actually outweight the entire tax savings of a 401K. And see if you can't get some change to happen.

It's been done before, and remember that all your co-workers and almost certainly most of your bosses are putting their retirement savings there too. People have gotten things improved before, with a little effort :)
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A lot depends on the tax laws when you retire. I've got three quarters of my overall holdings in the taxable portion of my portfolio, but I always maxed my 401k. If I had to guess, I think the Dems will raise income tax rates whenever they get the chance down the road, possibly to levels not seen since the 1970s. They also would love to raise the rate on cap gains and everything else. It's not an easy thing to figure out what you're trying to figure out. For me, I couldn't put any more in tax-deferred accounts, because of my income level, so putting everything else in a taxable account was my only choice. All and all, I would have done it anyway, because I have more control over the taxable portfolio. I left the rat race at 49, although I still do a little part-time consulting, so I haven't had to withdraw anything from my taxable portfolio for living expenses. If you are planning on retiring early, you likely would do well to have something tucked away in a taxable account. The idea of IRAs and such is that you'll be in a lower tax bracket after you retire. I never thought my tax bracket would go down much, and it hasn't. I think it's dropped about 1% or so in the 6 years since I left my firm. I think many people won't see their tax rate go down all that much, so paying a lower cap gains rate might be better than paying the income tax rate.
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my greateast fear is that the spineless dems will figure out the some us listened and saved and now our money has grown so much that it is not fair to those who have not..a special tax on 401ks and means testing for social security..i find it amusing that they passed laws on companies funding their pension obligations and turn a blind eye on social security...can anyone show me a politician in dc, house or senate with balls other than hillary
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tktampa: "My greateast fear is that the spineless dems will figure out the some us listened and saved and now our money has grown so much that it is not fair to those who have not..a special tax on 401ks and means testing for social security.."

Social security is already means-tested and has been for quite some time.

Regards, JAFO
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