should I stop 401K contributions as I ready to retire?

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills.
Post Reply
Topic Author
oharaj
Posts: 8
Joined: Mon Jan 05, 2015 10:10 am

should I stop 401K contributions as I ready to retire?

Post by oharaj »

My wife and I are in our mid 50s and about two years from retirement. We are in the upper tax brackets now and expect to remain there in retirement. Should I stop contributing to our 401K after we get our company match? What is the advantage of deferring income when the tax rate is likely to remain the same?
Don't handicap your children by making their childhoods easy.
User avatar
Clever_Username
Posts: 1915
Joined: Sun Jul 15, 2012 12:24 am
Location: Southern California

Re: should I stop 401K contributions as I ready to retire?

Post by Clever_Username »

You put the money into the 401(k) and save at the top marginal rate; it grows tax free and comes out, more or less, at your effective rate for that year. So, even if your marginal bracket remains the same, you still get to fill the 0% "bucket", the 10% "bucket" etc on your way to whatever your marginal rate is. So maybe you pay a little less tax on that money.

Downside: potentially higher RMDs in a little under two decades.

Potential change: If you're fine paying the marginal rate on those dollars today, is Roth 401(k) available? That way, it grows tax free, you grab the money when/if you need it, no RMDs, tax is pre-paid.

Caveat: I'm in my early 30s and expect to be in a lower tax bracket when I retire, so my current plan includes making any traditional contributions I can, pretty much whenever I can.
"What was true then is true now. Have a plan. Stick to it." -- XXXX, _Layer Cake_ | | I survived my first downturn and all I got was this signature line.
livesoft
Posts: 86075
Joined: Thu Mar 01, 2007 7:00 pm

Re: should I stop 401K contributions as I ready to retire?

Post by livesoft »

If your tax rate remains the same, then no advantage to not contributing, so you might as well contribute because most people really don't know their tax rate in retirement and usually over-estimate it.
Wiki This signature message sponsored by sscritic: Learn to fish.
FreemanB
Posts: 374
Joined: Thu May 22, 2014 5:55 am

Re: should I stop 401K contributions as I ready to retire?

Post by FreemanB »

oharaj wrote:What is the advantage of deferring income when the tax rate is likely to remain the same?
I would look at it from the other direction: What is the advantage of paying taxes on the income now if the future tax rate is likely to be the same? At worst, there's virtually no difference. At best, you end up paying less taxes. Do you have some compelling reason to stop the contributions and use the money for something else? If not, why change it?
Topic Author
oharaj
Posts: 8
Joined: Mon Jan 05, 2015 10:10 am

Re: should I stop 401K contributions as I ready to retire?

Post by oharaj »

thanks for taking the time to read/respond.

Roth and Roth conversions are not doable due to existing traditional IRA holdings.

No better use for the money today, I'm just trying to determine if there is any consideration other than the future marginal tax rate. If I believe the marginal rates will be higher when I start taking RMD's in 4 years, then I should stop funneling money into my 401K and simply pay the marginal rates today.

Maybe as a simple protection against the likelihood of a higher marginal tax rate, I should be funding my taxable accounts until such time as my taxable and tax-deferred accounts are 50-50 of my (investment) net worth.
Don't handicap your children by making their childhoods easy.
User avatar
Toons
Posts: 14467
Joined: Fri Nov 21, 2008 9:20 am
Location: Hills of Tennessee

Re: should I stop 401K contributions as I ready to retire?

Post by Toons »

Continue Contributing :happy
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee
chocolatemuffin
Posts: 155
Joined: Thu Apr 28, 2011 1:56 am

Re: should I stop 401K contributions as I ready to retire?

Post by chocolatemuffin »

There's value in contributing to 401K even if your tax rate stays the same. For simplicity, let's assume the tax rate is always 20%, the rate of return is 5% per year, and the investment horizon is 10 years.

Case 1: 401k
- Each dollar compounds at 5% per year, then 20% tax is paid for the entire amount at the end of the 10-year period.
- (1.05)^10 * 0.8 = 1.30.

Case 2: Taxable
- 20% tax is paid at the beginning, then each dollar compounds at 4% per year (5% * 0.8) because tax needs to be paid every year.
- 0.8 * (1.04)^10 = 1.18.

EDIT: This is of course a simplification. There are other considerations (e.g. capital gain tax doesn't need to get paid until sold, and potential step-up basis at death).

EDIT 2: Effect of 401k is similar to Roth IRA if tax rate is the same at contribution and withdrawal time.
Last edited by chocolatemuffin on Wed Jan 07, 2015 3:21 pm, edited 1 time in total.
user5027
Posts: 971
Joined: Sat Jun 16, 2012 8:54 pm

Re: should I stop 401K contributions as I ready to retire?

Post by user5027 »

oharaj wrote:thanks for taking the time to read/respond.

Roth and Roth conversions are not doable due to existing traditional IRA holdings.

No better use for the money today, I'm just trying to determine if there is any consideration other than the future marginal tax rate. If I believe the marginal rates will be higher when I start taking RMD's in 4 years, then I should stop funneling money into my 401K and simply pay the marginal rates today.

Maybe as a simple protection against the likelihood of a higher marginal tax rate, I should be funding my taxable accounts until such time as my taxable and tax-deferred accounts are 50-50 of my (investment) net worth.
In your first post you say you and your wife are mid 50's. RMDs start at age 70 not in 4 years.
FreemanB
Posts: 374
Joined: Thu May 22, 2014 5:55 am

Re: should I stop 401K contributions as I ready to retire?

Post by FreemanB »

oharaj wrote:No better use for the money today, I'm just trying to determine if there is any consideration other than the future marginal tax rate. If I believe the marginal rates will be higher when I start taking RMD's in 4 years, then I should stop funneling money into my 401K and simply pay the marginal rates today.
Just to be sure, did you mean your RMD's in 14 years instead of 4? I wouldn't try to speculate on my tax rates after that period of time, since anything could change. Also, even if marginal rates are higher, income needed to hit those rates will likely also be higher, so you could still end up paying less if you defer the taxes now.
Topic Author
oharaj
Posts: 8
Joined: Mon Jan 05, 2015 10:10 am

Re: should I stop 401K contributions as I ready to retire?

Post by oharaj »

Penalty-free distributions start at age 59½.
Don't handicap your children by making their childhoods easy.
User avatar
dratkinson
Posts: 6116
Joined: Thu Jul 26, 2007 6:23 pm
Location: Centennial CO

Re: should I stop 401K contributions as I ready to retire?

Post by dratkinson »

The short answer. More tax-advantaged space is better than less. No RMD (Roth IRA) is better than required RMD.

The long answer.
http://www.irs.gov/Retirement-Plans/Ret ... tributions

What types of retirement plans require minimum distributions?

The RMD rules apply to all employer sponsored retirement plans, including
profit-sharing plans, 401(k) plans, 403(b) plans, and 457(b) plans. The RMD rules also apply to traditional IRAs and IRA-based plans such as SEPs, SARSEPs, and SIMPLE IRAs.

The RMD rules also apply to Roth 401(k) accounts. However, the RMD rules do not apply to Roth IRAs while the owner is alive.
Contribute the max to your 401k, or to a Roth 401k to stop the taxes on withdrawals.

Contribute the max to a Roth IRA, or if required, to a back door Roth IRA.

Investigate your 401k options to see if in-service rollovers are allowed for a Roth IRA conversion. Work on this, staying in your tax bracket, until you retire. And after you retire.

Avoiding Required Minimum Distributions from Roth 401(k)s
http://www.kiplinger.com/article/retire ... tions.html



Many years ago I converted my tIRA to a rIRA. Did it foolishly as a lump sum, and took a huge tax hit. But it was less than the taxes I'd owe now, in the same tax bracket, on the growth since then.

Do your Roth IRA conversions so you don't advance tax brackets.
d.r.a., not dr.a. | I'm a novice investor; you are forewarned.
cherijoh
Posts: 6591
Joined: Tue Feb 20, 2007 3:49 pm
Location: Charlotte NC

Re: should I stop 401K contributions as I ready to retire?

Post by cherijoh »

oharaj wrote:My wife and I are in our mid 50s and about two years from retirement. We are in the upper tax brackets now and expect to remain there in retirement. Should I stop contributing to our 401K after we get our company match? What is the advantage of deferring income when the tax rate is likely to remain the same?
Do you have enough money outside of tax-deferred accounts to live on until you hit 59.5 and can draw on your retirement accounts without penalty? If the answer is NO, then I would recommend cutting back on your 401k contributions to build up this buffer. Otherwise, you may want to keep contributing - especially if you have a few years where you can live off your taxable accounts and only pay capital gains tax.

I am in this situation - I will likely retire in a few years and be dependent on my taxable portfolio. My current portfolio is 60% in traditional (Rollover IRA + 401k), 26.5% in taxable, 12.4% in Roth IRA, and 1.1% in an Inherited IRA. I'm still contributing to my traditional 401k, since I am currently in the 25% marginal tax bracket. Once a DB pension and SS kick in (plan to take at 60 and 70, respectively) I will be solidly in the 25% bracket again. However, in early retirement I'll be in the 15% bracket and plan to do Roth conversions to reduce my future RMDs.
User avatar
Watty
Posts: 28859
Joined: Wed Oct 10, 2007 3:55 pm

Re: should I stop 401K contributions as I ready to retire?

Post by Watty »

oharaj wrote:My wife and I are in our mid 50s and about two years from retirement. We are in the upper tax brackets now and expect to remain there in retirement. Should I stop contributing to our 401K after we get our company match? What is the advantage of deferring income when the tax rate is likely to remain the same?

One thing to consider is how close you will be to the top of your current tax bracket when you retire. If you will not be near the top of your tax bracket then you could do Roth conversions at that same tax bracket in a few years.

If your choice turns out to be;

1) Pay 33% taxes on $10,000 income now because you don't do the 401K now then have $6,666 in a taxable account.
2) Put the $10,000 into a 401K now, then in three years you can do a $10,000 Roth conversion and have $6,666 in a Roth that will never be taxed again.

Then #2 becomes an easy choice.
User avatar
Ged
Posts: 3945
Joined: Mon May 13, 2013 1:48 pm
Location: Roke

Re: should I stop 401K contributions as I ready to retire?

Post by Ged »

It is possible that if you are in the same nominal tax bracket in retirement you could be in a higher EFFECTIVE tax bracket because of taxation of social security benefits and state taxes. This could make further contributions to IRAs disadvantageous. It will take some work to figure out if this is the case.
gwrvmd
Posts: 820
Joined: Wed Dec 02, 2009 7:34 pm
Location: Calabash NC

Re: should I stop 401K contributions as I ready to retire?

Post by gwrvmd »

Oharaj; It is true that penalty free withdrawals can begin at 59.5 but why would you want to pay taxes at 59 when you could put off paying taxes until over 70? If you are that anxious to pay taxes why contribute to a 401(k) at all?.......Gordon
Disciple of John Neff
User avatar
Svensk Anga
Posts: 1612
Joined: Sun Dec 23, 2012 4:16 pm

Re: should I stop 401K contributions as I ready to retire?

Post by Svensk Anga »

I think the discussion above missed one possibility. Marginal tax rates being the same are only a consideration for ordinary income (401k withdrawals and taxable interest included). If the potential contributions go into equities in a taxable account instead, investment gains will be taxed at the lower qualified dividend and long term capital gains rates (assuming this preferential treatment is durable). Capital gains may not be taxed at all if they go to heirs with a step up in basis. If the OP now in his mid 50's lives to normal life expectancy, the investment gains are likely to dwarf the original contributions so taxes on earnings becomes more important than taxes on the potentially deferred salary.

On the other hand, if heirs are likely to be in a lower tax bracket, they might be better off inheriting the 401k or IRA.
User avatar
Clever_Username
Posts: 1915
Joined: Sun Jul 15, 2012 12:24 am
Location: Southern California

Re: should I stop 401K contributions as I ready to retire?

Post by Clever_Username »

oharaj wrote:Roth and Roth conversions are not doable due to existing traditional IRA holdings.

That's a backdoor Roth you're thinking of. Contributing to a Roth 401(k) directly, if the option exists in your workplace plan, is unaffected by any and all holdings in a traditional IRA.
"What was true then is true now. Have a plan. Stick to it." -- XXXX, _Layer Cake_ | | I survived my first downturn and all I got was this signature line.
User avatar
Watty
Posts: 28859
Joined: Wed Oct 10, 2007 3:55 pm

Re: should I stop 401K contributions as I ready to retire?

Post by Watty »

oharaj wrote:Penalty-free distributions start at age 59½.

From a 401K if you are still employed in the year you turn 55 that is normally the age when you can start the 401k distributions without penalty.
User avatar
gasdoc
Posts: 2042
Joined: Mon Nov 03, 2014 7:26 am

Re: should I stop 401K contributions as I ready to retire?

Post by gasdoc »

I would add that there is no way of knowing what future tax rates will be- therefore the recommendation might be to diversify- contribute the max, and try to get a portion converted to Roth so that you have some pre tax and some post tax.
User avatar
N1CKV
Posts: 864
Joined: Wed Mar 21, 2012 8:18 am

Re: should I stop 401K contributions as I ready to retire?

Post by N1CKV »

oharaj wrote:Roth and Roth conversions are not doable due to existing traditional IRA holdings.
You seem confused. They are suggesting Roth 401k Contributions (if your plan has a Roth option), which Traditional accounts do not exclude. (IRA conversions are a different story, but aren't relevant for this question.)
oharaj wrote:Penalty-free distributions start at age 59½.
There is a difference between when you can take a penalty free distribution and when Required Minimum Distributions (RMD) begin.

You would be missing the opportunity to delay paying the taxes on a Traditional contribution and allowing that money to grow tax deferred.
If passed on making Roth contributions you would be giving up the opportunity to allow that money to grow tax free, unless you needed the money before 59 1/2 why would you want to give up the opportunity for FREE/never taxed capital gains and distributions on that money?
Topic Author
oharaj
Posts: 8
Joined: Mon Jan 05, 2015 10:10 am

Re: should I stop 401K contributions as I ready to retire?

Post by oharaj »

'Thanks to all for the replies. A couple of further comments and summary of my new direction....

To my original question as to whether I should contribute to my 401K beyond the company match, the consensus seems to be that while it may be only marginally beneficial, given my tax brackets and investment window, it also has little downside. I've got the disposable income to fund it, so I should continue to do so.

One of the key suggestions raised is that I need to go back and look into backdoor ROTH IRAs. I'll have to look into reverse rollover from my current retirement account(s), (the difficulty lies in determining deductible contributions plus earnings) but the effort to fund a ROTH account will be a better use of my time and disposable income.

Thanks to all for your comments.
Don't handicap your children by making their childhoods easy.
User avatar
Clever_Username
Posts: 1915
Joined: Sun Jul 15, 2012 12:24 am
Location: Southern California

Re: should I stop 401K contributions as I ready to retire?

Post by Clever_Username »

oharaj wrote:One of the key suggestions raised is that I need to go back and look into backdoor ROTH IRAs. I'll have to look into reverse rollover from my current retirement account(s), (the difficulty lies in determining deductible contributions plus earnings) but the effort to fund a ROTH account will be a better use of my time and disposable income.
No, that's pretty much the opposite of some suggestions, unless I'm mis-reading it.

The suggestion was that, if you are okay paying the taxes now on 2015's contributions only, you can add it to a Roth 401(k). This pays the taxes now and has the effect, once you leave, of having added it to a Roth IRA, which is where that portion of the 401(k) would go. It has nothing to do with traditional IRAs or the amount held in pre-tax accounts and doesn't cause you to pay taxes on any previous additions.
"What was true then is true now. Have a plan. Stick to it." -- XXXX, _Layer Cake_ | | I survived my first downturn and all I got was this signature line.
Topic Author
oharaj
Posts: 8
Joined: Mon Jan 05, 2015 10:10 am

Re: should I stop 401K contributions as I ready to retire?

Post by oharaj »

Let me be clearer. ROTH 401K is not an option in our current employer(s) retirement accounts. ROTH IRAs are not an option as we are above the MAGI limit.

The only ways to take advantage of ROTH benefits is via a back-door conversion. In order to be able to contribute to and utilize a back-door conversion, first I have to separate the pre and post tax contributions in my existing IRA.
Don't handicap your children by making their childhoods easy.
User avatar
gasdoc
Posts: 2042
Joined: Mon Nov 03, 2014 7:26 am

Re: should I stop 401K contributions as I ready to retire?

Post by gasdoc »

I believe you have got it figured out.
User avatar
dratkinson
Posts: 6116
Joined: Thu Jul 26, 2007 6:23 pm
Location: Centennial CO

Re: should I stop 401K contributions as I ready to retire?

Post by dratkinson »

oharaj wrote:Let me be clearer. ROTH 401K is not an option in our current employer(s) retirement accounts. ROTH IRAs are not an option as we are above the MAGI limit.

The only ways to take advantage of ROTH benefits is via a back-door conversion. In order to be able to contribute to and utilize a back-door conversion, first I have to separate the pre and post tax contributions in my existing IRA.
(1) You (his and her's) can do a back-door Roth with your new contribution(s) every year. Should only be paperwork. Contribute to a tIRA. Immediately convert to a rIRA. As conversion happens immediately, there is no chance for growth, so no additional taxes owed due to conversion.


You are correct, converting past tIRAs to a Roth is a little more work. Your taxable amount (the growth) is easy to figure out: it's everything converted that you didn't contribute.

(2) If you split conversion up over multiple years, to make it simpler, assume contributed basis and growth are proportional, so keep track of converted basis and growth for each split. Next year work on reduced remaining contributed basis and any new growth. Adjust initial number/size of splits so taxes on converted growth portion do not advance your tax bracket.

Do (1) as long as you have earned income.
Do (2) until you are done.
d.r.a., not dr.a. | I'm a novice investor; you are forewarned.
Post Reply