401(k) vs Taxable on a low income

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perihelion
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401(k) vs Taxable on a low income

Post by perihelion » Thu Jan 10, 2019 1:07 pm

Hi all! So far I have been able to answer all my questions by searching the forum, but this topic is complicated enough that I would like some confirmation. Most of the advice I have found on bad 401(k)'s is for those with high income. I am confident our taxable income will be below $77,200 when we want to access this money, which I think gives us a 0% LTCG tax. I don't get any company match, and I am already maxing out our IRA's. What is the benefit to a 401(k)?

My specifics:

On 7/6/2018 I invested $153.84 in GMRAX, with an expense ratio of 0.67% (the cheapest in my plan). My 9/28 statement showed a value of $154.26, and my 12/31 statement a value of $122.94. According to Yahoo Finance's adjusted closing numbers, my 12/31 value should have been $124.21, meaning a quarterly fee of $1.27, or 4.1% per year.

My statement also listed
Nationwide Administrative Expenses $0.00 and
Advisory/Service Provider Expenses $XX.XX, which works out to 0.6%/year of my total balance. This is the mandatory adviser fee which I knew about going in.

My questions at this point are:
1) Is my math correct?
2) Is the 0.6% fee included in the 4.1% or is it additional?

There remains the question of whether taxable is any better. I made a quick spreadsheet for my case, with these assumptions:
Withdrawal halfway between leaving the company and the start of taking social security.
401(k) fees = 1.27% (the minimum possible)
current marginal tax rate = 12% federal + 6.33% NY
retirement tax rate = 12% federal + 3.07% PA
cap. gains tax rate = 0% federal + 3.07% PA
Image
I found the result to vary strongly based on my amount of capital gains, so I made an Excel Data Table as a function of expected invest. return and time in 401k. The inner rectangle is my most likely scenario. It is slightly in favor of using a taxable account. If I use a 4.1% fee, taxable is overwhelmingly better.
Image
My questions here are:
1) Is the 0% LTCG tax correct?
2) If so, can I except it to be so when I retire? I know it used to be higher.
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perihelion
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Re: 401(k) vs Taxable on a low income

Post by perihelion » Fri Jan 11, 2019 5:10 pm

This is complicated by the $400 saver's credit I would get if I used the 401(k).
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grabiner
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Re: 401(k) vs Taxable on a low income

Post by grabiner » Fri Jan 11, 2019 10:10 pm

perihelion wrote:
Fri Jan 11, 2019 5:10 pm
This is complicated by the $400 saver's credit I would get if I used the 401(k).
You can get the Saver's Credit with an IRA as well, either traditional or Roth. If you don't get an employer match, max out your IRA in preference to contributing to the 401(k).

If you plan to retire in PA, you should prefer a traditional IRA, because contributions to the traditional IRA are deductible from NY tax, and PA doesn't tax withdrawals from an IRA.
Wiki David Grabiner

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perihelion
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Re: 401(k) vs Taxable on a low income

Post by perihelion » Thu Jan 17, 2019 3:40 pm

Thanks for your response. I added tax implications to my spreadsheet, and it is now a lot more complicated. I think it was too complicated to start out with, if my goal was get people to read my question. It is much easier to advise a noob who hasn't read the wiki. No, I don't get employer match, and yes, I'm already maxing out my IRA.

To close out this discussion, let me add this realization: if my returns are good, I can absorb the fees, whatever they are. I really have to pinch every penny when the returns are bad, which is when taxable investments are at their best. The same applies to fees - if you don't know what the fees are, it is safer to assume they are bad, and invest in taxable.
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mark1623
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Re: 401(k) vs Taxable on a low income

Post by mark1623 » Thu Jan 17, 2019 3:54 pm

Are Roth deferrals available in your 401(k) plan?

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perihelion
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Re: 401(k) vs Taxable on a low income

Post by perihelion » Thu Jan 17, 2019 4:34 pm

mark1623 wrote:
Thu Jan 17, 2019 3:54 pm
Are Roth deferrals available in your 401(k) plan?
Not as far as I can tell. Why? They seem like the opposite of what I want.
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MotoTrojan
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Re: 401(k) vs Taxable on a low income

Post by MotoTrojan » Thu Jan 17, 2019 4:47 pm

perihelion wrote:
Thu Jan 17, 2019 4:34 pm
mark1623 wrote:
Thu Jan 17, 2019 3:54 pm
Are Roth deferrals available in your 401(k) plan?
Not as far as I can tell. Why? They seem like the opposite of what I want.
Not sure what a Roth deferral is but a Roth contribution is best in a low tax bracket, and beats taxable no matter what bracket. Roth is after tax just like taxable and then grows tax-free (no dividend drag) and gets withdrawn tax-free. Unbeatable.

mark1623
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Re: 401(k) vs Taxable on a low income

Post by mark1623 » Thu Jan 17, 2019 5:51 pm

MotoTrojan wrote:
Thu Jan 17, 2019 4:47 pm
perihelion wrote:
Thu Jan 17, 2019 4:34 pm
mark1623 wrote:
Thu Jan 17, 2019 3:54 pm
Are Roth deferrals available in your 401(k) plan?
Not as far as I can tell. Why? They seem like the opposite of what I want.
Not sure what a Roth deferral is but a Roth contribution is best in a low tax bracket, and beats taxable no matter what bracket. Roth is after tax just like taxable and then grows tax-free (no dividend drag) and gets withdrawn tax-free. Unbeatable.
Employee contributions to 401k's are called salary deferrals.

Agree on the substance. If Roth 401k is available it beats taxable under just about all possibilities except the one where OP actually ends up paying 0% capital gains tax, in which case the Roth option is only slightly ahead (due to dividends).

Only downside to the Roth 401k is that you may not be able to access earnings prior to 59.5. If you plan to retire well before then, you might want to mix it up a little to maintain tax diversity.

MotoTrojan
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Re: 401(k) vs Taxable on a low income

Post by MotoTrojan » Thu Jan 17, 2019 8:29 pm

mark1623 wrote:
Thu Jan 17, 2019 5:51 pm
MotoTrojan wrote:
Thu Jan 17, 2019 4:47 pm
perihelion wrote:
Thu Jan 17, 2019 4:34 pm
mark1623 wrote:
Thu Jan 17, 2019 3:54 pm
Are Roth deferrals available in your 401(k) plan?
Not as far as I can tell. Why? They seem like the opposite of what I want.
Not sure what a Roth deferral is but a Roth contribution is best in a low tax bracket, and beats taxable no matter what bracket. Roth is after tax just like taxable and then grows tax-free (no dividend drag) and gets withdrawn tax-free. Unbeatable.
Employee contributions to 401k's are called salary deferrals.

Agree on the substance. If Roth 401k is available it beats taxable under just about all possibilities except the one where OP actually ends up paying 0% capital gains tax, in which case the Roth option is only slightly ahead (due to dividends).

Only downside to the Roth 401k is that you may not be able to access earnings prior to 59.5. If you plan to retire well before then, you might want to mix it up a little to maintain tax diversity.
You can withdraw contributions from a Roth IRA, is a Roth 401k converted to Roth okay? If so that should be plenty for the interim period.

mark1623
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Re: 401(k) vs Taxable on a low income

Post by mark1623 » Thu Jan 17, 2019 9:54 pm

MotoTrojan wrote:
Thu Jan 17, 2019 8:29 pm
mark1623 wrote:
Thu Jan 17, 2019 5:51 pm
MotoTrojan wrote:
Thu Jan 17, 2019 4:47 pm
perihelion wrote:
Thu Jan 17, 2019 4:34 pm
mark1623 wrote:
Thu Jan 17, 2019 3:54 pm
Are Roth deferrals available in your 401(k) plan?
Not as far as I can tell. Why? They seem like the opposite of what I want.
Not sure what a Roth deferral is but a Roth contribution is best in a low tax bracket, and beats taxable no matter what bracket. Roth is after tax just like taxable and then grows tax-free (no dividend drag) and gets withdrawn tax-free. Unbeatable.
Employee contributions to 401k's are called salary deferrals.

Agree on the substance. If Roth 401k is available it beats taxable under just about all possibilities except the one where OP actually ends up paying 0% capital gains tax, in which case the Roth option is only slightly ahead (due to dividends).

Only downside to the Roth 401k is that you may not be able to access earnings prior to 59.5. If you plan to retire well before then, you might want to mix it up a little to maintain tax diversity.
You can withdraw contributions from a Roth IRA, is a Roth 401k converted to Roth okay? If so that should be plenty for the interim period.
Yes Roth contributions always come out tax and penalty free. Counts the same if those contributions were initially made to a 401k and then rolled over.

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perihelion
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Re: 401(k) vs Taxable on a low income

Post by perihelion » Fri Jan 18, 2019 8:24 am

I assume a Roth 401(k) would have the same 4% fee as my 401(k), which is what I'm trying to avoid in the first place. I expect to have 0% cap gains tax at the federal level, but non-zero state.
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retiringwhen
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Re: 401(k) vs Taxable on a low income

Post by retiringwhen » Fri Jan 18, 2019 9:23 am

In a situation where you can’t know the answer before hand with a high degree of confidence, i would punt and go 50/50.

I am in a similar place regarding using Roth IRA/401(K) vs pre-tax. I decided to hedge my bets a bit and essentially go 75/25 pre-tax / Roth, but I have a much lower ER and a 100% match up to 5% of income so the 401(k) is a no-brainer to start with. But, I cannot reasonably draw a line on my marginal tax rate in retirement to demonstrate true value for a Roth (there is a very good chance i will retain my current tax rates in retirement for a long time, but they could go up if the market is good to our portfolio)

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teen persuasion
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Re: 401(k) vs Taxable on a low income

Post by teen persuasion » Fri Jan 18, 2019 11:11 am

OP, are you MFJ with kids?

For low income with kids, contributing to traditional 401k is far superior to either taxable or tIRA, if the reduction to your AGI gets you a larger EITC, which is refundable. If you are in NY, then it is even greater because there is a NY version of EITC, matching 30% of the federal EITC.

Taxable investment income > $3400 makes you completely ineligible for EITC.

Traditional IRA contributions reduce AGI, but not line 7 wages; EITC is tested on both (and you receive whichever result is lower), so you want them as close as possible (and generally as low as possible if in the phaseout range). Contributions to 401k reduce both, as do payroll HSA contributions.

The EITC phaseout rate is 21%, so contributions to DH's 401k increase our tax refunds by 21% + 6.3% for the NY (30% match of EITC) + 10% Fed tax avoided + 4% NY tax avoided. That's 41.3% return on contributions. I use those refunds to fund Roth IRAs for us - Roth here, because there's no further advantage to traditional IRA contributions for us as we've reached zero federal tax (other nonrefundable credits like the Saver's credit, AOTC, CTC) and as I explained before traditional IRA contributions can't further reduce line 7 wages to increase EITC.

If your conditions align well, you could increase refundable credits significantly by favoring traditional 401k over tIRA or taxable. Your income would need to be near the EITC cutoff, so that traditional 401k contributions bring you well into the credit range. More children have higher credit limits and higher absolute credits.

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perihelion
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Re: 401(k) vs Taxable on a low income

Post by perihelion » Fri Jan 18, 2019 11:46 am

Yes, MFJ with kids in NY. However, I can't get my income low enough for the EITC (mostly because no payroll health plan). It would be during retirement, but I don't think I want taxable investment income < $3550 then (assuming this means dividends + cap gains). This is good information though, thanks!
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teen persuasion
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Re: 401(k) vs Taxable on a low income

Post by teen persuasion » Fri Jan 18, 2019 1:52 pm

Yeah, assuming retirement = zero earnings, then no EITC (earned income tax credit) at that point, either.

adam1712
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Re: 401(k) vs Taxable on a low income

Post by adam1712 » Fri Jan 18, 2019 2:17 pm

perihelion wrote:
Thu Jan 10, 2019 1:07 pm
...

My specifics:

On 7/6/2018 I invested $153.84 in GMRAX, with an expense ratio of 0.67% (the cheapest in my plan). My 9/28 statement showed a value of $154.26, and my 12/31 statement a value of $122.94. According to Yahoo Finance's adjusted closing numbers, my 12/31 value should have been $124.21, meaning a quarterly fee of $1.27, or 4.1% per year.

...
Hold up, an adjusted closing number typically means adjusted for dividends. It's used to show the return if dividends are reinvested. You receive the dividends, you don't lose them to fees.

I don't have time to double-check specifically for GMRAX but I think you are thinking about the fees incorrectly and including dividends as fees rather than returns.

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perihelion
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Re: 401(k) vs Taxable on a low income

Post by perihelion » Fri Jan 18, 2019 3:19 pm

adam1712 wrote:
Fri Jan 18, 2019 2:17 pm
...
I don't have time to double-check specifically for GMRAX but I think you are thinking about the fees incorrectly and including dividends as fees rather than returns.
I'm hoping you're right - that's why I asked - but I am in fact reinvesting dividends, and running the numbers any other way gives nonsensical answers.

https://finance.yahoo.com/quote/GMRAX/history?p=GMRAX
9/28/2018 . . . Close: 15.56 . . . Adj Close 10.73
12/31/2018 . . . 8.64
https://money.stackexchange.com/questio ... -dividends
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