BIGSeth wrote:

- quote -

The 'downside' if any, of a 401 is first, the fees, which you've
addressed, that your's were low. Second, is the conversion of long term
cap gains (now 15% tops) to ordinary income (35% or higher). Third
(last) is the risk of saving your way to a higher tax bracket, in
general, this should be the least of your worries, just something to
keep in the back of your mind as time goes on.
Again, in general, I believe the risk is that rates will rise, both
income tax, and capital gains rates. (Rising income tax suggests
throttling back the 401 if the balance grows too high, but higher cap
gains favors the 401). So, in the end a mix of pre and post tax savings
is indicated.
JOE

The important thing is to save 15% or so, then look
for the tax-advantaged savings methods first.
IRS tax-deferred accounts are designed for the middle
class and top out at AGIs of $100K thereabouts.
Then you have to saving like rich people- capital gains
you dont have to sell for a long time.
Index stock funds are fairly well diversified (safe-ish)
and defer most of their capital gains until you sell them.
Real estate is another deferred gain investment that
some people swear by.

- quote -

My comment would be to "max" 401k as a good place to start and learn.
After a certain period of time, you may see value to changing your tax
strategy- maybe the amount you set aside projects you to retire in the
33% tax bracket, maybe it will project you to 25% tax bracket. Each
of this situations might suggest a different strategy. Early
retirement may even suggest a third (different) strategy.

Side questions
1) depends on when you withdraw (what age) and the tax bracket you are
in. Because you are starting your 401k first, it will be "bigger"- a
larger part of your picture. Adding other pieces (taxable
investments, Roth accounts, other holdings) you will see them
differently. Generally 10k ina 401k is worth less than 10k in a
taxable account which is worth less than 10k in a Roth account. Maybe
a 5-10% factor between each. The higher the tax bracket, the more the
Roth is favored.

2) No idea- so use "tax diversification"- hold different assets which
will be taxed in different ways. Roth, taxable accounts, 401k
accounts, other.

Thanks to everyone for the advice. It is much appreciated.

So the general consensus seems to be:

Max out the 401k assuming the fees aren't too high (which they seem
not to be). Taxes would have to go up quite a bit to overcome the
deferral advantages and the potential increase in capital gains taxes
seems just as likely.

Sound right?


Side questions:

1. Personally, how much more would you have to earn in a 401k vs. a
taxable account to feel it was worth having your money tied up for
that long?
2. How do you think the tax situation will change by 2045 considering
the state of Social Security? Does this change the strategy?


Thanks again,

Seth

jIM wrote:
- quote -

I drone on about when to reverse 3 and 4 at
http://www.joetaxpayer.com/401rip.html
I base it on any extra expenses within the 401(k) compared to the
external post-tax account.

JOE

On Apr 10, 7:42 am, "BIG Seth" <bigs...[at]gmail.com> wrote:
- quote -

Pulling up my spreadsheet, I'm going to use the following numbers:
* 38.60% tax for your regular income
* 15% tax for the best case scenario of having all your money in
growth index funds w/ only 0.5% dividend yield per year
* Contributing $2000 per month after-tax or $3257 before-tax. I'm
ignoring the 15.5K yearly employee contribution limit in order to
illustrate the math.
* 10% annualized return

5 years
taxable: 143K
401K: 146K
break-even future tax rate: 40.5%

10 years
taxable: 361K
401K: 383K
break-even: 42%

20 years
taxable: 1.24M
401K: 1.37M
break-even: 44.5%

30 years
taxable: 3.44M
401K: 3.95M
break-even: 46.5%

So if your time frame is 30 years, your current tax rate of 38.6%
would have to increase to 46.5% before a 401K gives you less money.
This is for the case where you put 100% of your assets into Large Cap
Growth and Small Cap Growth indexes.

If you have diversified portfiolio, the numbers are even more
advantaged towards the 401K option because now you have 2%+ dividend
yields subject to yearly taxes. Let me give you the numbers for that:
* 2% dividend yield
* income tax rate of 17.5% to account for bond div/reit div/stcg not
qualifying for the the 15% rate

5 years
taxable: 142K
401K: 146K
break-even: 41%

10 years
taxable: 356K
401K: 383K
break-even: 43%

20 years
taxable: 1.2M
401K: 1.37M
break-even: 46.5%

30 years
taxable: 3.3M
401K: 3.95M
break-even: 49%

One final note. Don't assume LTCG/QDIV will always have a 15% taxable
rate. It was higher in the past and it probably will be higher in the
future. Bump it up to 20% or 25% or the previous rate of 28%,
retirement options really stomp taxable accounts into the ground.

"jIM" <noreplysoccer[at]hotmail.com> writes:
- quote -

A quick back-of-the-envelope computation shows that tax-deferral
overwhelms lower rates over time:
Assumptions: investment grows at 10%/yr,
taxable account taxed at 25%/yr ever year on that 10%
deferred acct taxed at 40% when liquidated
current marginal rate of 25% (ie. invest $10k in 401k
or $7.5k in taxableacct):
For the first 9 years, you have more spendable money in
the taxable account
after year 1: $8062 vs. $6600 ($11000 * 0.6 for taxes)
after year 9: $14379 vs. $14147

After that, compounding at the higher rate totally trounces it:
after year 20: $31858 vs. $40364 ($67274 * 0.6 for taxes)

Now there are a lot of bad assumptions here - the taxable
account is *perfectly* taxable, for example, whereas it
could have been stuck into a tax-efficient index fund and
be effectively tax-deferred for the most part as well as
ultimately taxable at long-term-cap-gains rates. A *lot*
of basically crappy assumptions (rate of return, tax rates,
etc. etc.) But the basic point stands - tax deferral
may generate exponentially better long-term results -
literally.

Moreover, a tax-deferred account gives you lots more
flexibility to do things like rebalance without having
to worry about taxes. Very helpful if you want to
make the portfolio more conservative later on.

Lastly, you may ultimately get an opportunity to
roll it into a Roth at some point (perhaps stopping
in a regular IRA on the way). If you do that at
a point when your marginal rates are low (ie. if
you take year off of work for some reason) you may
come out way ahead.


--
Plain Bread alone for e-mail, thanks. The rest gets trashed.
No HTML in E-Mail! -- http://www.expita.com/nomime.html
Are you posting responses that are easy for others to follow?
http://www.greenend.org.uk/rjk/2000/06/14/quoting

On Apr 10, 10:42 am, "BIG Seth" <bigs...[at]gmail.com> wrote:
- quote -

I'd start with 10% of gross income to 401ks. The most important
factors to saving are setting money aside and making sure the money
grows moderately. The 401k takes some guesswork out of this. Getting
the tax deferral on the gains is also a good thing. You could do much
worse than just invest in 401k... you MIGHT be able to do better, but
many options would be "worse".

You don't know about future taxes, so using tax diversification might
be in order.

I might suggest contributing some money to a taxable account and/or
traditional IRA. In 2010 the income restrictions on Roth conversions
are removed, so you could contribute to a traditional now, convert it
in 3 years and have some money in a Roth flavored account.

Generally the options suggested are

1) contribute to 401k up to match
2) max out Roth
3) max out 401k
4) taxable accounts

with some discussion of possibly reordering 3 and 4 in some
situations.

You can do 1)- but no match.
You cannot do 2) (income)
You can do 3)
You can do 4)

A mix of 401k and taxable accounts is acceptable. Saving 10% of
income is a good step to financial independance. 2k "after tax"
might be closer to 2300 "pre tax", so the 401k allows you to put more
money to work in your favor now, and get a tax break as well.

Please forgive me if this question has been answered already but I'm
having a hard time finding responses to my situation.

I'm 30 years old and currently live in New York City (taxes about 7%
state and 3.6% city). I'm in the 28% tax bracket and make too much now
to contribute to my Roth IRA. My company offers a 401k without
matching but with a decent selection (Vanguard Index funds, etc.) of
investment options. I can save about 2k a month after taxes or more
with a 401k + after tax investing combination.

My question is, what should I do?

Without the match the 401k seems a bit suspect. I understand the tax
deferral, but I'm worried that taxes may actually go up by the time I
retire. They seem relatively cheap now and I'm worried Social
Security
costs may push taxes higher. Conversely, I may live in a lower tax
state (almost any, I'd guess) at retirement. There may be a major
shift to taxes (national sales tax, flat tax, etc) as well.

Any thoughts would be greatly appreciated and please correct me if I'm
wrong on any of the information above.


Take care,


Seth