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If at first you don't succeed...

I'm going to admit my ignorance and take a second stab at this. AND I'm going to include the responses of those Fools who have been nicely offered (free!) help so far. Here's the story:

I have $5000 in 401(k) with a previous employer. My goal is to invest that 5k for the best long term results.

Option 1) I can roll it into a new 401(k) with my new employer. They offer a 50% match up to 6% of my income. In a given year, I could contribute $3900 and my company (bless their little hearts) would contribute $1950. However, my company's 401(k) does not contain an index fund. So I'd probably be choosing among the actively managed Kemper funds that are in the program.

Option 2) I can roll that money into an IRA...probably Roth. I am 26 and expect this money to sit for 25-30 years. My IRA would likely be a Foolish Four portfolio, so I'd only have to make modifications every year and a half.

Here's what I want to know:
1) Which option would you choose with your retirement money at my age?
2) Really important: Why?
3) What kind of return should I expect from these two options: I was theorizing 10% and 17%, respectively.

Below are the Foolish responses I've had so far. Thanks to mphipps, Sacto Fool, and ez2bhard for their advice. Please comment on my ideas and theirs. You'll see that there are differing opinions. Of course, that's what Fooldom is all about! Thanks in advance for all the help!

Rutabaga2000
The Official Rutabaga of the New Millenium

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rutabaga,

I would IMMEDIATELY roll the 5k out of the previous employers 401k and get it into a Roth. The ability to grow the 5K for 30+ years taxfree is a HUGE benefit to you. You will first have to roll the 401K into a regular IRA and then convert to a Roth IRA, and pay taxes on the converted amount. So make sure you can cover the tax bill with out of pocket expenses.

ez2bhard



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Let's see if I understand this correctly.

You defer 6%.
You get a 50% match (an additional 3%).
If you put that into an Index Fund you should get 10-12% retrun (0.9% - 1.08%).
For a total combined return of 65% - 68% on your original 6% deferal. (9.9% - 10.08% of your income total, including your original 6%.)

What kind of return were you expecting from the Foolish 4 again?

Sacto Fool


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IMHO you have these options to consider. IMO only these make sense. Not in order
1. Roll the money into Roth. 5K is small and if you you can handle the tax bit do . I think you can roll 401k into Roth. But you better checka and make sure. If they withhold 20% when you do it, then don't
2. Roll it over to IRA and invest in S&P 500 index or Technology fund.

mphipps


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Rutabaga,

I would disagree with your return assumptions. You're assuming you can maintain a 17% return over the long haul with the Foolish Four strategy. The Foolish Four returns go back 25 years, during a period when the stock market has significantly outperformed it's historical average.

Is your 10% return assumption based on an analysis of the Kemper funds offered in the 401K? How have the funds done relative to the Foolish Four and S & P 500 over 5 yrs.? 10 yrs? 15 yrs? I'm aware of several Kemper funds that have outperformed the Foolish Four and S & P 500.

I would use the same return assumptions of 10% for your analysis or, at the very most, give the IRA no more than a 2% advantage.

ez2bhard
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YOU WROTE:

Option 1) I can roll it into a new 401(k) with my new employer. They offer a 50% match up to 6% of my income. In a given year, I could contribute $3900 and my company (bless their little hearts) would contribute $1950. However, my company's 401(k) does not contain an index fund. So I'd probably be choosing among the actively managed Kemper funds that are in the program.

Option 2) I can roll that money into an IRA...probably Roth. I am 26 and expect this money to sit for 25-30 years. My IRA would likely be a Foolish Four portfolio, so I'd only have to make modifications every year and a half.

Here's what I want to know:
1) Which option would you choose with your retirement money at my age?
2) Really important: Why?
3) What kind of return should I expect from these two options: I was theorizing 10% and 17%, respectively.

MY ANSWER:

1. ROLL THE MONEY INTO AN IRA, THEN CONVERT TO ROTH AND PAY THE TAX. WHY? ALL FUTURE GAINS ARE TAX FREE IN THE ROTH.

2. MAXIMIZE ON THE 401(K) TO GET ALL THE FREE MONEY FROM YOUR EMPLOYER. REVIEW THE KEMPER FUNDS HISTORY FOR BEST RETURNS, LOWEST COSTS. REMEMBER THAT THEY WOULD HAVE TO DO PRETTY AWFUL TO CHEW THROUGH THE 50% EMPLOYER FREE MONEY. EVEN IF THEY UNDERPERFORM THE MARKET THE FREE MONEY WILL MORE THAN MAKE UP FOR IT.

3. WHAT KIND OF RETURN CAN YOU EXPECT? HOW GOOD IS YOUR OR KEMPER'S CRYSTAL BALL? THIS GOES BACK TO ANSWER 1. DO YOU HAVE STOCK PICKING SKILLS? IF NOT THEN TAKE ADVANTAGE OF THE THING YOU HAVE THE MOST OF...TIME. I WOULD TAKE THE ROTH MONEY AND EITHER PUT SOME IN A VANGUARD INDEX (CHEAPEST IN ADMINISTRATION COSTS) AND SOME IN A TECHNOLOGY INDEX FUND. THE OTHER ALTERNATIVE IS TO SET UP THE ROTH WITH A DISCOUNT BROKER AND BUY SPIDERS (SPY), THE EQUIVALENT OF AN S&P INDEX AND (QQQ) (THE NASDAQ TOP 100). FINALLY KEEP MAKING CONTRIBUTIONS ANNUALLY TO THE ROTH IF YOU QUALIFY. AT YOUR AGE, WITHOUT TOO MUCH RISK, YOU WILL HAVE A FABULOUS PORTFOLIO AT 55 IF ALL YOU DO IS MATCH THE MARKET.

BTW, I THOUGHT ALL THE REPLIES WERE GOOD ADVICE.

HAVE FUN!

BILL
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I have $5000 in 401(k) with a previous employer. My goal is to invest that 5k for the best long term results.

Option 1) I can roll it into a new 401(k) with my new employer. They offer a 50% match up to 6% of my income. In a given year, I could contribute $3900 and my company (bless their little hearts) would contribute $1950. However, my company's 401(k) does not contain an index fund. So I'd probably be choosing among the actively managed Kemper funds that are in the program.

Option 2) I can roll that money into an IRA...probably Roth. I am 26 and expect this money to sit for 25-30 years. My IRA would likely be a Foolish Four portfolio, so I'd only have to make modifications every year and a half.


Okay, I missed the part about having the $5,000 to roll before. I would probably look for a low cost broker (not just trading cost, but annual fees on the IRA, transfer fees, etc.) and roll the $5,000 there. If you have at least 5-10 years before retirement and can pay the current taxes from your other income, immediately converting that "conduit IRA" into a Roth IRA would probably be the Foolish thing to do.

As far as the 401(k)is concerned, find a way to put the 6% in to take FULL advantage of the company match. Your returns may be sub-par, but the 50% company match puts you WAY out in front! (The first year you'd have to LOSE over 26% in order to equal just a 10% gain on your contribution without the company match.) Granted, long term it's not such a great option, but you have time to campaign for them to add an index fund before you REALLY fall behind.

Once you've gotten the full company match on the 401(k), you have a choice to make. If you're sure you'll reliably put the money into the account from each of your paychecks, the Roth IRA is probably the better bet. But if you have any doubt about your ability to stick to it even though the car needs new tires, your third cousin is graduating from grammer school, or whatever else might come up, then having your employer pull the money out of your check before you have a chance to touch it may be the better bet.
Also, the tax benefit of putting the money into 401(k) isn't something to be ignored. If you pulled $2,000 out of the portion that WOULD have gotten a company match to put into a Roth and you're in the 28% tax bracket, you'd have to not defer almost $2,800 and lose an additional $1,400 in company match. So instead of having $4,200 in the 401(k), you'll only have $2,000 in the Roth IRA.

The best of all worlds? Convince your employer to add an index fund to the 401(k) options, max that out completely, and STILL put the $2,000 into the Roth.

I'm not quite there yet, but after 2 years I've gotten my employer to add the index fund and I've gotten my finances to where I can find a way to live on what's left after they pull the maximum 17% allowed under their plan document. (Not to be confused with the $10,500 deferal/25% total contribution allowed by the IRS.) And I'm currently in the process of refinancing my home to pay off my credit cards as such which should free up another $100+/month to be put aside for future Roth contributions. (I'm pulling $4,000 out of the refi to make my 1999 & 2000 contributions.)

But then, I'm facing the real possability of having to go out on permanent disability before I hit 40 in 7 years so I don't have much time to save.....

Sacto Fool
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