maxed out 401k worth higher expense ratio (but less tax)?

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ploldo
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maxed out 401k worth higher expense ratio (but less tax)?

Post by ploldo »

I have plenty in my general investing account to try this for a few year if its worth it. To me it appears to be a tradeoff between tax savings now and higher expense ratios for many years.


If i max out my 401k contributing ~17k I save ~$3200 in taxes a year. But then I have to invest in my companies 401k fund provider which is not a great one like Vanguard with low expense ratios. Is investing 17k tax deferred but with approx .3% higher expense ratios better than 17k invested in a standard non tax shielded investment account with low expense ratios? I am 27. If i was close to retiring obviously this would be worth it.


A related question is whether or not I can instead invest this money for the 401k into Vanguard...but I'm guessing my company has a contract with this poor company so I'm stuck with them.
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grabiner
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Re: maxed out 401k worth higher expense ratio (but less tax)

Post by grabiner »

The real benefit isn't the $3200 you save in taxes this year, but the opportunity for tax-deferred growth. If your $17,500 grows to $175,000 before you retire, and you withdraw it at the same tax rate, you will get $143,000 after tax, which is just as good as investing $14,300 tax-free.

For an extra 0.3%, it's clearly worth investing in the 401(k) in preference to taxable investing. If you hold a taxable stock index fund with a 2% qualified dividend yield (usually the best holding for a taxable account), you will lose 0.3% to taxes every year you hold the fund, and you will also pay taxes on capital gains. In addition, once you retire (or leave the employer), you can roll your 401(k) over to an IRA and get rid of the extra expenses; if you had a taxable investment, you could not get rid of the extra expenses except by selling the funds (and paying capital-gains tax).
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mlewis
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Re: maxed out 401k worth higher expense ratio (but less tax)

Post by mlewis »

I agree with above comment.
But you could also invest 5k less per year in the 401k and put that money into an IRA (roth or trad, I prefer Roth). That way you would have great expense ratios if you opened it with a place like Vanguard, and tax-free growth as well.

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grabiner
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Re: maxed out 401k worth higher expense ratio (but less tax)

Post by grabiner »

mlewis wrote:I agree with above comment.
But you could also invest 5k less per year in the 401k and put that money into an IRA (roth or trad, I prefer Roth). That way you would have great expense ratios if you opened it with a place like Vanguard, and tax-free growth as well.
And if you can afford to do both (max out the 401(k) and Roth IRA), then you should do both before any taxable investing, by the same logic.
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ploldo
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Re: maxed out 401k worth higher expense ratio (but less tax)

Post by ploldo »

Great replies. Thanks.

I just got an email today saying my company will soon be offering Roth 401ks. I assume this is (usually) clearly the best case?

This is really good news for me. Will probaly save hundres of thousands in taxes. I'm 27 and converted my SEP to a ROTH last year, plus this ROTH 401k now - should have almost $200k in my ROTH in a few years. I've been very forunate and this forum has helped so much.
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interplanetjanet
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Re: maxed out 401k worth higher expense ratio (but less tax)

Post by interplanetjanet »

ploldo wrote:Great replies. Thanks.

I just got an email today saying my company will soon be offering Roth 401ks. I assume this is (usually) clearly the best case?
No, not usually. Where do you get this assumption from?

http://thefinancebuff.com/case-against-roth-401k.html
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grabiner
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Re: maxed out 401k worth higher expense ratio (but less tax)

Post by grabiner »

ploldo wrote:I just got an email today saying my company will soon be offering Roth 401ks. I assume this is (usually) clearly the best case?
Wiki article link: Traditional versus Roth

It is not usually the best choice, but it may be the best for you. The Roth 401(k) effectively tax-defers more money, but you may pay tax at a higher rate now than you would pay on retirement with a traditional 401(k). In particular, if you put too much in Roth accounts, you will waste some of the lower tax brackets in retirement. However, since you are 27, you are probably paying tax at a lower rate now than you will be paying later in your career; your claim of $3200 in tax on a $17,000 401(k) investment implies a 19% combined federal and state tax bracket. Therefore, you may be better off using the Roth 401(k) now and switching to a traditional 401(k) when you earn a higher salary and are in the 25% federal tax bracket.
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ploldo
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Re: maxed out 401k worth higher expense ratio (but less tax)

Post by ploldo »

Thanks, that makes sense. I thought the whole marginal tax rate argument was too simplistic.

Does this logic apply to Roth vs Traditional IRAs too? Roth seems to be much more preferred here but I can't figure out why.
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grabiner
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Re: maxed out 401k worth higher expense ratio (but less tax)

Post by grabiner »

ploldo wrote:Does this logic apply to Roth vs Traditional IRAs too? Roth seems to be much more preferred here but I can't figure out why.
The Traditional-versus-Roth decision is the same for an IRA or a 401(k). However, most investors who would be better off with a Traditional IRA than a Roth (because of high current tax brackets) do not have the option for a deductible Traditional IRA because of the income limits.

If you already have a Traditional IRA, then deciding whether to convert it to a Roth is the standard Traditional-versus-Roth decision; converting a $5000 Traditional IRA to a Roth has the same effect as contributing $5000 to a Roth rather than to a Traditional IRA.
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retiredjg
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Re: maxed out 401k worth higher expense ratio (but less tax)

Post by retiredjg »

ploldo wrote:Roth seems to be much more preferred here but I can't figure out why.
It might appear that way, but there is no preference for Roth here. In fact, I'd say there is a definite preference for traditional.

What seems to be a preference for Roth is probably suggestions to people who are not eligible for deducting their contributions to traditional IRA. If you are going to get taxed anyway, it should go to Roth.

This would be true for the cohort of people who are not eligible for deducting but are eligible for Roth and the cohort of people who are not eligible for either, but who can get money into Roth IRA through the "back door".

So yes, the word Roth does get tossed around a lot, but there is no preference for it if traditional (with deductions) is available. The exception would be for people in very low tax brackets.
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ploldo
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Re: maxed out 401k worth higher expense ratio (but less tax)

Post by ploldo »

Wow, interesting. Will probably go with traditional from now on.


I convert my SEP IRA to a ROTH this year. I was a full time student so hopefully this was smart.
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retiredjg
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Re: maxed out 401k worth higher expense ratio (but less tax)

Post by retiredjg »

ploldo wrote:Wow, interesting. Will probably go with traditional from now on.
Before you do that, you should be sure you are in the 25% tax bracket or higher.

I convert my SEP IRA to a ROTH this year. I was a full time student so hopefully this was smart.
If your tax bracket was low (such as the result of being a student) it probably was smart.
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