401k vs After Tax Investments

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username5588
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401k vs After Tax Investments

Post by username5588 » Thu Sep 03, 2015 2:07 pm

I am newly eligible to invest in my firms 401k plan. So far I have been maxing out my Roth IRA and then puting the rest in after tax investments in Mutual Funds in Vanguard. They have low expense ratios. The options for 401k have higher expense ratios. How can I determine which of the two options is more beneficial-401K with higher expense ratios or after tax investment with lower expense ratios?

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Phineas J. Whoopee
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Re: 401k vs After Tax Investments

Post by Phineas J. Whoopee » Thu Sep 03, 2015 3:21 pm

Hi username5588, and welcome to the forum!

The first question is whether your employer offers a 401(k) contribution match. If it does, up to that level it's an immediate 100% (or 50% or whatever) return on your investment.

It takes a lot of expense ratio differential over a long time to cut your account's value in half.

PJW

sawhorse
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Re: 401k vs After Tax Investments

Post by sawhorse » Thu Sep 03, 2015 3:52 pm

First, what is your tax bracket?

Second, could you post a list of the investment options along with their expenses and any additional fees? Please give the names, not just the ticker symbols. We need to see exactly how high the expense ratios are and how good the options are.

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username5588
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Re: 401k vs After Tax Investments

Post by username5588 » Thu Sep 03, 2015 3:58 pm

My employer is generous enough that they contribute regardless of if employees do or not. We are invested through Charles Schwab, so I believe we are able to chose any investment that they offer. Upon looking at their website, I got the general idea that the expense ratios were higher than Vanguard. I am in the 25% tax bracket. Currently taxed at about 15%

sawhorse
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Re: 401k vs After Tax Investments

Post by sawhorse » Thu Sep 03, 2015 4:08 pm

username5588 wrote:My employer is generous enough that they contribute regardless of if employees do or not. We are invested through Charles Schwab, so I believe we are able to chose any investment that they offer. Upon looking at their website, I got the general idea that the expense ratios were higher than Vanguard. I am in the 25% tax bracket. Currently taxed at about 15%
Given that tax bracket and the fact that you can invest at anything with Schwab, which has several low-cost options comparable to Vanguard, this is a no-brainer. Contribute as much as you can to the 401k. Maxing out the contribution ($18,000) is an immediate $4500 tax savings this year.

I'm shaking my head that people have become so fixated on expense ratios that they would be willing to forgo a 25% tax reduction in order to get a 0.5% reduction on expense ratios. [OT comment removed by admin LadyGeek]

Edit: It's much smaller than a 0.5% difference in expense ratios according to the Schwab website. There might be additional fees that the employer passes onto participants, though they still would be peanuts compared to the tax savings.

http://www.schwab.com/public/schwab/inv ... uity/index

randomguy
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Re: 401k vs After Tax Investments

Post by randomguy » Thu Sep 03, 2015 4:19 pm

sawhorse wrote:
username5588 wrote:My employer is generous enough that they contribute regardless of if employees do or not. We are invested through Charles Schwab, so I believe we are able to chose any investment that they offer. Upon looking at their website, I got the general idea that the expense ratios were higher than Vanguard. I am in the 25% tax bracket. Currently taxed at about 15%
Given that tax bracket and the fact that you can invest at anything with Schwab, which has several low-cost options comparable to Vanguard, this is a no-brainer. Contribute as much as you can to the 401k. Maxing out the contribution ($18,000) is an immediate $4500 tax savings this year.

I'm shaking my head that people have become so fixated on expense ratios that they would be willing to forgo a 25% tax reduction in order to get a 0.5% reduction on expense ratios. [OT comment removed by admin LadyGeek]

Edit: It's much smaller than a 0.5% difference in expense ratios according to the Schwab website. There might be additional fees that the employer passes onto participants, though they still would be peanuts compared to the tax savings.

http://www.schwab.com/public/schwab/inv ... uity/index
It is more of a 25% tax deferrement and not savings but the general point stands. Schwab has a ton of cheap index funds and ETFs. The ETF has a .04% (20% cheaper than vangurad) and the mutual fund is like .09. I wouldn't lose sleep over any of them. This sounds like a nonproblem.

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Re: 401k vs After Tax Investments

Post by sawhorse » Thu Sep 03, 2015 4:21 pm

randomguy wrote: It is more of a 25% tax deferrement and not savings but the general point stands.
Yes, thanks for the correction. The expectation is that you'll be in a lower bracket when the time comes to pay those taxes.

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FiveK
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Re: 401k vs After Tax Investments

Post by FiveK » Thu Sep 03, 2015 4:23 pm

username5588 wrote:I am in the 25% tax bracket. Currently taxed at about 15%
If that 15% is your overall tax rate, ignore it. The marginal rate of 25% is what is important for this question.

See http://www.bogleheads.org/forum/viewtop ... 0&t=172808 and links therein. In short, based on what you have presented, investing in the 401k seems a great deal for you.

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Re: 401k vs After Tax Investments

Post by LadyGeek » Thu Sep 03, 2015 4:48 pm

username5588, Welcome! Do you understand the answers given so far? If not, please say so and we'll try again. The hardest questions to answer are the ones not asked.
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Re: 401k vs After Tax Investments

Post by LadyGeek » Thu Sep 03, 2015 4:48 pm

I removed some off-topic comments. As a reminder to our experienced members, see: Please Do Not Bite the Newcomers
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username5588
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Re: 401k vs After Tax Investments

Post by username5588 » Fri Sep 04, 2015 8:03 am

This advice has helped a lot. Thank you. I cannot make the max contirbution as I only make 45k a year. I will try to figure out the max I can contirbute.

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Re: 401k vs After Tax Investments

Post by AviN » Fri Sep 04, 2015 8:41 am

username5588 wrote:This advice has helped a lot. Thank you. I cannot make the max contirbution as I only make 45k a year. I will try to figure out the max I can contirbute.
In terms of retirement investments, unless your 401(k) is really awful and you plan to stay at your current job for decades, you should probably max out your 401(k) before you invest anything for retirement in taxable. If you can't max out your 401(k) and you are early in your career, you still should sell your taxable retirement investments and move them to a 401(k) by temporarily maxing out or increasing your contributions.

Avi

rkhusky
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Re: 401k vs After Tax Investments

Post by rkhusky » Fri Sep 04, 2015 11:04 am

I find the second table at this page: http://www.bogleheads.org/wiki/Non-dedu ... tional_IRA, to be enlightening on comparing the differences between taxable, Traditional IRA, Roth IRA and non-deductible Traditional IRA. In your case, 401K is the same as Traditional IRA. The tax rates are likely not the same as yours, but the general result is likely to be the same.

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Re: 401k vs After Tax Investments

Post by sawhorse » Fri Sep 04, 2015 2:00 pm

username5588 wrote:This advice has helped a lot. Thank you. I cannot make the max contirbution as I only make 45k a year. I will try to figure out the max I can contirbute.
If you are single and don't have other sources of income, you're actually in the 15% bracket after standard deduction and exemption. That makes the decision more of a toss up because it's less clear that you'll be in a lower tax bracket when you retire.

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username5588
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Re: 401k vs After Tax Investments

Post by username5588 » Fri Sep 04, 2015 2:30 pm

sawhorse wrote:
username5588 wrote:This advice has helped a lot. Thank you. I cannot make the max contirbution as I only make 45k a year. I will try to figure out the max I can contirbute.
If you are single and don't have other sources of income, you're actually in the 15% bracket after standard deduction and exemption. That makes the decision more of a toss up because it's less clear that you'll be in a lower tax bracket when you retire.
That's part of what is making it difficult for me to decide. I am currently single at the moment. I am assuming I will be married and we will have two incomes when I retire

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Re: 401k vs After Tax Investments

Post by LadyGeek » Fri Sep 04, 2015 4:28 pm

username5588 - What is the answer to Phineas J. Whoopee's question? Bear in mind that "matching contribution" is not the same thing as contributing up to the max amount.
Phineas J. Whoopee wrote:The first question is whether your employer offers a 401(k) contribution match. If it does, up to that level it's an immediate 100% (or 50% or whatever) return on your investment...
If your employer kicks in with any type of contribution, it's a no-brainer to put everything into the 401(k).
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.

sawhorse
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Re: 401k vs After Tax Investments

Post by sawhorse » Fri Sep 04, 2015 8:07 pm

username5588 wrote:That's part of what is making it difficult for me to decide. I am currently single at the moment. I am assuming I will be married and we will have two incomes when I retire
Returns for married filling jointly have different bracket boundaries, so the fact that you would be married then in theory probably won't affect your tax bracket unless your spouse makes a lot more and also retires after you. And of course between now and then the tax laws could change a lot.

If you were solidly in the 25% bracket, I would certainly contribute. But it seems like you're actually in the 15% bracket, not the 25% bracket.

I would definitely contribute up to the match if you get any match. Beyond that I'm not sure. Do you have any debts? If so, I'd pay those before the 401k.

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username5588
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Re: 401k vs After Tax Investments

Post by username5588 » Sat Sep 05, 2015 10:54 am

I am luck enough that I do not have any debt. I do not live beyond my means and that enables me to save

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username5588
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Re: 401k vs After Tax Investments

Post by username5588 » Sat Sep 05, 2015 10:55 am

LadyGeek wrote:username5588 - What is the answer to Phineas J. Whoopee's question? Bear in mind that "matching contribution" is not the same thing as contributing up to the max amount.
Phineas J. Whoopee wrote:The first question is whether your employer offers a 401(k) contribution match. If it does, up to that level it's an immediate 100% (or 50% or whatever) return on your investment...
If your employer kicks in with any type of contribution, it's a no-brainer to put everything into the 401(k).
My employer is generous enough that they will contributed regardless of if we do or not

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Re: 401k vs After Tax Investments

Post by ruralavalon » Sat Sep 05, 2015 3:17 pm

Welcome to the forum :).
username5588 wrote:I am luck enough that I do not have any debt. I do not live beyond my means and that enables me to save
It's great to hear that you have no debt. That's always great way to start.

username5588 wrote:My employer is generous enough that they contribute regardless of if employees do or not. We are invested through Charles Schwab, so I believe we are able to chose any investment that they offer. Upon looking at their website, I got the general idea that the expense ratios were higher than Vanguard. . . . . .
What contribution does your employer make to your 401k?

What are the lowest expense ratio funds (please give fund names tickers, & expense ratios) offered in your 401k?

Are any or all of these Schwab funds offered in your 401k?
Schwab 1000 Index Fund (SNXFX)
Schwab Total Stock Market Index Fund (SWTSX)
Schwab S&P 500 Index Fund (SWPPX)
Schwab Small-Cap Index Fund (SWSSX)
Schwab International Index Fund (SWISX)
Schwab total bond market index fund (SWLBX)
Schwab short term bond index fund (SWBDX).

username5588 wrote:This advice has helped a lot. Thank you. I cannot make the max contirbution as I only make 45k a year. I will try to figure out the max I can contirbute.
About how much do you estimate that you might be able to contribute to investing annually in the foreseeable future?

Do you have an emergency fund set aside, enough to cover a few months worth of living expenses in an emergency?

What is your age?

About how long do you expect that you might be with this employer?
. . . . .

You can provide answers by adding to your original post using the edit button. It helps a lot to have all of your information in one place.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

inbox788
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Re: 401k vs After Tax Investments

Post by inbox788 » Sat Sep 05, 2015 5:48 pm

So, how much of an EF is the difference? I haven't seen any specific funds mentioned yet.
Besides the EF difference, you also have to consider how long you're going to be at the job and under the 401k plan, and if you can escape it when you quit. OP, how old are you? Is this a short/mid term job, or are you going to retire there? If you knew you were in this for the long haul, say 25 or 30 years and the EF was more than 1%, then it's clear to me taxable is the one I'd choose. Short term, you can live with the high expense fees. Since it's never clear, maybe best guess and hedging by choosing a little of both may give you a less than optimal, but less than worst case outcome.

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Re: 401k vs After Tax Investments

Post by username5588 » Tue Sep 08, 2015 7:42 am

inbox788 wrote:So, how much of an EF is the difference? I haven't seen any specific funds mentioned yet.
Besides the EF difference, you also have to consider how long you're going to be at the job and under the 401k plan, and if you can escape it when you quit. OP, how old are you? Is this a short/mid term job, or are you going to retire there? If you knew you were in this for the long haul, say 25 or 30 years and the EF was more than 1%, then it's clear to me taxable is the one I'd choose. Short term, you can live with the high expense fees. Since it's never clear, maybe best guess and hedging by choosing a little of both may give you a less than optimal, but less than worst case outcome.

Pardon my ignorance, but what do you mean by "EF"?

I am 30 years old. I plan to stay at this job long term, but again you never know what the future holds. As for retiring here, who knows if the company will still even be aorund in 30+ years

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Re: 401k vs After Tax Investments

Post by Lafder » Tue Sep 08, 2015 8:40 am

As others are saying, max your pretax contributions to lower your income taxes now. Put more away now to grow bigger over time.

List your available fund options with ERs and we can help pick the best options.

ER is expense ratio

EF I thought was Emergency fund, but I am not sure that is how inbox788 meant it. I think they meant what is the difference in Expense Ratio, which we all want to see :)

lafder

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Re: 401k vs After Tax Investments

Post by NateInCT » Tue Sep 08, 2015 9:08 am

username5588 wrote:
LadyGeek wrote:username5588 - What is the answer to Phineas J. Whoopee's question? Bear in mind that "matching contribution" is not the same thing as contributing up to the max amount.
Phineas J. Whoopee wrote:The first question is whether your employer offers a 401(k) contribution match. If it does, up to that level it's an immediate 100% (or 50% or whatever) return on your investment...
If your employer kicks in with any type of contribution, it's a no-brainer to put everything into the 401(k).
My employer is generous enough that they will contributed regardless of if we do or not
But how much will they contribute, up to what percentage of your income? Employers will usually contribute a certain % of your salary as matching contributions then stop at a certain point. I have never heard of it being unlimited.

Or (rarely) they will do something like contribute 3% on your behalf then contribute an additional matching percentage as you contribute, up to "X%". You see an arrangement like that more often when your company offers a pension plan. The first percentage is for the pension and is required, then the match is for the additional 401k or 403b that you can contribute to on your own. You could replace that example with a million others that would be just as accurate.

Point is, every company match works a little differently so any details about how their match works would be helpful. Though, any match makes it worth it to contribute so its more a matter of picking the funds and the % you want to contribute than if you should contribute.

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FiveK
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Re: 401k vs After Tax Investments

Post by FiveK » Tue Sep 08, 2015 9:14 am

inbox788 wrote:If you knew you were in this for the long haul, say 25 or 30 years and the EF was more than 1%, then it's clear...
If only it were this straightforward. As it stands, more information (e.g., the individual's current and projected tax rates for ordinary, dividend, and capital gains) is needed before addressing this.

Someone in the 33% bracket now, expecting to be in the 25% bracket (with 15% QD and LTCG rates) when withdrawing, holding in the 401k for 25 years, then rolling over into an IRA and withdrawing 5 years later would be better in the 401k for up to ~1.3% extra fees.

See either of the tools noted in the wiki discussion: '401k vs Taxable' tab or alternatives to high cost 401k.

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Re: 401k vs After Tax Investments

Post by goingup » Tue Sep 08, 2015 9:31 am

username5588-
If I were you I'd take advantage of the automated savings opportunity of the 401K. Try setting it up for 10% if possible. You'll lower your taxable income and may not even miss the money from your paycheck. Automated savings work well because it removes the decision making from investing. Your contributions just keep buying shares in good times and bad.

No doubt you'll find low-cost options at Schwab--look for the index funds.

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username5588
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Re: 401k vs After Tax Investments

Post by username5588 » Tue Sep 08, 2015 10:02 am

NateInCT wrote:
username5588 wrote:
LadyGeek wrote:username5588 - What is the answer to Phineas J. Whoopee's question? Bear in mind that "matching contribution" is not the same thing as contributing up to the max amount.
Phineas J. Whoopee wrote:The first question is whether your employer offers a 401(k) contribution match. If it does, up to that level it's an immediate 100% (or 50% or whatever) return on your investment...
If your employer kicks in with any type of contribution, it's a no-brainer to put everything into the 401(k).
My employer is generous enough that they will contributed regardless of if we do or not
But how much will they contribute, up to what percentage of your income? Employers will usually contribute a certain % of your salary as matching contributions then stop at a certain point. I have never heard of it being unlimited.

Or (rarely) they will do something like contribute 3% on your behalf then contribute an additional matching percentage as you contribute, up to "X%". You see an arrangement like that more often when your company offers a pension plan. The first percentage is for the pension and is required, then the match is for the additional 401k or 403b that you can contribute to on your own. You could replace that example with a million others that would be just as accurate.

Point is, every company match works a little differently so any details about how their match works would be helpful. Though, any match makes it worth it to contribute so its more a matter of picking the funds and the % you want to contribute than if you should contribute.

Ohh ok, got it. They contribute 4% of your salary, which for this year will be $1800. No further matching after that.

I am still waiting to open an account and look at all of the choices, but as far as I understand we are able to chose any investment thourgh Charles Schwab.

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Re: 401k vs After Tax Investments

Post by alex_686 » Tue Sep 08, 2015 11:17 am

username5588 wrote:That's part of what is making it difficult for me to decide. I am currently single at the moment. I am assuming I will be married and we will have two incomes when I retire
You are trying to predicted what your draw will be from your portfolio, tax policy, marriage, etc. in 30+ years. I would skip this step - to many moving parts. I would recommend a 50/50 split between pre-tax and post-tax contribution. You will be right on one of your selections. :happy

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Re: 401k vs After Tax Investments

Post by NateInCT » Thu Sep 10, 2015 8:34 am

Since they are already contributing 4% without you doing anything, that's a major win. If i did the math right, you are making 45k a year and it sounds like you have a long time horizon to retirement. Personally, I would invest all that I comfortably could into a Roth and let that sucker grow for as long as possible, but that's me. The longer you have to invest, the greater the benefit a Roth (along with all investments really, but especially a roth) will be in retirement.

If you decide you need the tax break now instead of later, contribute additional money to the 401k. There are a few things to consider for this in your case.
First, since you can pick any fund from Schwab you have a good quality selection of cheap funds to choose from. Many people aren't that lucky :D
Second, the maximum contribution is much higher in the 401k. If you were able to contribute more than $5,500 to retirement, you would need to do it in the 401k anyway since you cant contribute more than that to IRA accounts collectively. Granted, this may be a moot point since at 45k salary you probably can't contribute that much, unless you are especially thrifty and debt free, but your income will hopefully be going up in the future so its something to keep in mind. Given the above couple points, staying in the 401k would just be easier to manage so you can focus more on your job and life and less on your investments.

You could also meet in the middle and split the difference contributing whatever you are comfortable and increase contributions as time goes on.

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Re: 401k vs After Tax Investments

Post by ThisTimeItsDifferent » Thu Sep 10, 2015 9:14 am

Does your employer offer a 401k Roth option for your contributions? The employer match has to be traditional/deductible but many offer the non deductible, tax free growth option of Roth for the employee contribution. If you are at the 15% marginal tax rate now, that might be a good option.

It gives you higher contribution limits than the Roth IRA, better ERISA lawsuit/bankruptcy (?) protection, and better withdrawal options (age 55, loans, and potentially no RMDs at age 70). Are there any ways that the IRA is better? Only more options, but if you have the ultra low cost index choices in fidelity, vanguard or Schwab, then who cares?

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Re: 401k vs After Tax Investments

Post by ruralavalon » Thu Sep 10, 2015 2:58 pm

username5588 wrote:I am newly eligible to invest in my firms 401k plan. So far I have been maxing out my Roth IRA and then puting the rest in after tax investments in Mutual Funds in Vanguard. They have low expense ratios. The options for 401k have higher expense ratios. How can I determine which of the two options is more beneficial-401K with higher expense ratios or after tax investment with lower expense ratios?
./ . . . .

Ohh ok, got it. They contribute 4% of your salary, which for this year will be $1800. No further matching after that.

I am still waiting to open an account and look at all of the choices, but as far as I understand we are able to chose any investment thourgh Charles Schwab.
What is your marginal tax rate, both federal and state?

About how long do you expect that you might be with this employer?

Have you confirmed that in your 401k you can use any Schwab mutual fund? What are the expense ratios to use them in your 401k?

What funds are you now using in your Roth IRA, what amounts, and where is that IRA located?

What funds are you using in your taxable account at Vanguard, and what amounts?

After maxing your Roth IRA, what additional amount do you expect that you might be able to contribute to investing annually?
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ThisTimeItsDifferent
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Re: 401k vs After Tax Investments

Post by ThisTimeItsDifferent » Fri Sep 11, 2015 8:55 am

ThisTimeItsDifferent wrote:[a 401k Roth] gives you higher contribution limits than the Roth IRA, better ERISA lawsuit/bankruptcy (?) protection, and better withdrawal options (age 55, loans, and potentially no RMDs at age 70). Are there any ways that the IRA is better? Only more options, but if you have the ultra low cost index choices in fidelity, vanguard or Schwab, then who cares?
I suppose a Roth IRA allows you to withdraw contributions, but not earnings, earlier than a Roth 401k does. I am unaware of any other advantages of the Roth IRA over the Roth 401k.

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Re: 401k vs After Tax Investments

Post by ThisTimeItsDifferent » Mon Sep 14, 2015 1:50 pm

I did not consider nor mention that another advantage of the Roth IRA over the Roth 401k is that the Roth IRA has no RMD while the Roth 401k has an RMD at the later of age 70.5 or retirement. My earlier comment at potentially no RMDs at 70.5 for a 401k applies to traditional 401k plans compared to traditional IRAs. In both Roth cases, the distribution is non-taxable but the Roth IRA allows continued tax free earnings inside it.

I was reminded of this via PM. Thanks.

http://www.irs.gov/Retirement-Plans/RMD ... ion-Plans)
Note: There are no RMD requirements for a Roth IRA while the owner is alive. However, designated Roth accounts (i.e. Roth 401k's) are subject to the RMD rules.

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