"Bad" 401K or Taxable Account

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BoggledHead2
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Joined: Tue Jun 12, 2018 6:50 pm

"Bad" 401K or Taxable Account

Post by BoggledHead2 » Tue Jun 12, 2018 6:56 pm

I receive a 4% match (end of fiscal year lump sum) on my contributions ... but the fees/costs are pretty bad (1.5 - 2% between fund + "management" fees).

22% fed tax bracket ... should I simply contribute to the match and divert the rest to a taxable account or is it still prudent to max out the 401K and get the tax savings now. I also max out my Roth IRA annually - so i view this as a bit of "tax diversification". Smart? Way off? Any help would be appreciated. I hate the costs, but was always told the 401K max out + Roth max out was "the way to go". I am able to live my life and still sock away around $500 to other savings every month.

Should I 1. MAX ROTH 2. MAX 401K 3. then TAXABLE ?

I have a 20+ year investment horizon, so this is all long term money/outlook. Thank you BogleHeads!

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badbreath
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Re: "Bad" 401K or Taxable Account

Post by badbreath » Tue Jun 12, 2018 9:42 pm

yes do this
Should I 1. MAX ROTH 2. MAX 401K 3. then TAXABLE ?
you may change jobs and have better funds or your current employer could change and have a better place to invest it.
“While money can’t buy happiness, it certainly lets you choose your own form of misery.” Groucho Marx

PFInterest
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Re: "Bad" 401K or Taxable Account

Post by PFInterest » Tue Jun 12, 2018 9:45 pm

BoggledHead2 wrote:
Tue Jun 12, 2018 6:56 pm
I receive a 4% match (end of fiscal year lump sum) on my contributions ... but the fees/costs are pretty bad (1.5 - 2% between fund + "management" fees).

22% fed tax bracket ... should I simply contribute to the match and divert the rest to a taxable account or is it still prudent to max out the 401K and get the tax savings now. I also max out my Roth IRA annually - so i view this as a bit of "tax diversification". Smart? Way off? Any help would be appreciated. I hate the costs, but was always told the 401K max out + Roth max out was "the way to go". I am able to live my life and still sock away around $500 to other savings every month.

Should I 1. MAX ROTH 2. MAX 401K 3. then TAXABLE ?

I have a 20+ year investment horizon, so this is all long term money/outlook. Thank you BogleHeads!
Yes. Go talk to HR and get things changed.

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FiveK
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Re: "Bad" 401K or Taxable Account

Post by FiveK » Tue Jun 12, 2018 10:26 pm

See Expensive or mediocre choices for some guidance on this.

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grabiner
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Re: "Bad" 401K or Taxable Account

Post by grabiner » Wed Jun 13, 2018 9:48 pm

How long do you expect to stay with this employer?

An extra 1.5% expenses is enough that you might come out ahead in a taxable account if you stay with this employer for more than 20 years. But if you leave before the 20 years are up, you can roll your high-cost 401(k) into a low-cost IRA, keeping the tax deferral while getting rid of the expenses.

Regardless, you should max out any other tax-advantaged savings in preference to the 401(k) beyond the match: HSA if your health insurance allows one, Roth IRA, 529 for your children's college.
Wiki David Grabiner

ExitStageLeft
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Re: "Bad" 401K or Taxable Account

Post by ExitStageLeft » Thu Jun 14, 2018 7:45 am

The calculation on which is better depends on your tax rates now and when you retire. If your future tax rate will be comparable to today then it's better to put it in taxable. If your future rate is lower, which is likely for most people, then it gets a little harder to decide. Based on some assumptions, we can see where that decision point is:

Annual contrib $10,000
Current marginal tax rate 22%
Future effective tax rate 10%
Annual return 7%
401k fees 2%
Taxable fees 0.05%

Based on twenty years of contributing with that annual return, your account would have a balance of $330,659. Taxes on that would be $33,066, leaving you $297,593

If instead you put that $10,000 a year into a taxable account, after paying taxes on the wages and earnings it would end up with a balance of $275,364. The fees would have to be pretty bad to make taxable more appealing. If everything else is constant, taxable is only better when fees climb as high as 2.75%.

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FiveK
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Re: "Bad" 401K or Taxable Account

Post by FiveK » Thu Jun 14, 2018 9:29 am

ExitStageLeft wrote:
Thu Jun 14, 2018 7:45 am
The calculation on which is better depends....
See [Wiki suggestion] Invest in taxable or 401(k)? - Bogleheads.org for a couple of spreadsheets referenced in that thread, which one may use to quantify one's own situation.

sco
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Re: "Bad" 401K or Taxable Account

Post by sco » Thu Jun 14, 2018 6:47 pm

Factor in your term of employment, and the fact that benefits do change over time.

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grabiner
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Re: "Bad" 401K or Taxable Account

Post by grabiner » Thu Jun 14, 2018 8:03 pm

ExitStageLeft wrote:
Thu Jun 14, 2018 7:45 am
The calculation on which is better depends on your tax rates now and when you retire. If your future tax rate will be comparable to today then it's better to put it in taxable. If your future rate is lower, which is likely for most people, then it gets a little harder to decide. Based on some assumptions, we can see where that decision point is:

Annual contrib $10,000
Current marginal tax rate 22%
Future effective tax rate 10%
Annual return 7%
401k fees 2%
Taxable fees 0.05%

Based on twenty years of contributing with that annual return, your account would have a balance of $330,659. Taxes on that would be $33,066, leaving you $297,593

If instead you put that $10,000 a year into a taxable account, after paying taxes on the wages and earnings it would end up with a balance of $275,364.
Three notes on the math:

The decision should be made separately every year. It might be better to use the taxable account for the first year, then switch to the 401(k) in the second year because it is worth paying 19 years of expenses but not 20.

The growth continues well after you retire, as you won't spend your entire 401(k) or taxable account in the year you retire. If you use the 401(k), you keep many more years of tax-deferred growth; it might be 10 years to the time you use the average dollar.

And you should use the future marginal tax rate, not the effective rate, because the decision is made every year. You are comparing whether to use the taxable account or the 401(k) in the first year, given that you will use the 401(k) in the following 19 years. The difference in your 401(k)/IRA balance will only be the returns on this year's investment, and that difference will be taxed at your marginal rate.

So here is the example I would use:
Contribute $10,000 to 401(k) or $7800 to taxable
Invest for 20 years while working, then roll 401(k) to IRA for 10 more years
The stock market returns 8%, including 2% qualified dividends
Tax rate will be 15% in retirement, 0% on capital gains
Taxable investment and IRA cost 0.05% expenses

With these assumptions, the break-even rate for the 401(k) is 0.80% expenses. I thought that the cause was that these assumptions make the taxable account tax-free in retirement, since there is no tax on capital gains. However, it doesn't change much if I factor in the phase-in of Social Security taxation, which would make the tax rate 21% on ordinary income and 6% on capital gains if it affects half your retirement; actually, the break-even drops to 0.70%, as the capital-gains tax hurts you less on the smaller taxable account. If you retire at the same marginal tax rate, the break-even becomes 1.08%.

An important consideration for most employees is that you may not stay at the employer until retirement. If you change employers, the 401(k) looks much more attractive, because you will have more tax-deferred money in your IRA, rather than taxable money being taxed at your high rate while you are working.
Wiki David Grabiner

JBTX
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Re: "Bad" 401K or Taxable Account

Post by JBTX » Thu Jun 14, 2018 8:29 pm

I'd probably still do the 401k. Chances are you won't be there forever and will be able to roll it over to a rollover ira or another 401k, or if the tax rate is low enough maybe a Roth conversion.

Or maybe split the difference and do some taxable and some 401k.

One good thing about a 401k is you probably won't be tempted to cash it in for a big house or a large purchase you otherwise don't really need.

ExitStageLeft
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Re: "Bad" 401K or Taxable Account

Post by ExitStageLeft » Fri Jun 15, 2018 1:42 pm

I don't dispute that my analysis was simplistic, and wouldn't argue against any changes in assumptions in a subsequent analysis. I think it underscores very well the conclusion that it depends and it's may not be obvious for decades to come which choice is the best one.

It is also a strong argument to look for a better 401k plan, either with another employer or through petitioning current employer to improve the plan they provide.

fcf18
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Re: "Bad" 401K or Taxable Account

Post by fcf18 » Fri Jun 15, 2018 7:55 pm

I think you should at least contribute to 401k enough to get that 4% match, after that, it's a close call between using 401k vs taxable depending on many variable that no one knows. To be save and more flexible, maybe split some money between taxable and 401k?

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