Roth 401k or Traditional

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Topic Author
Boilermaker10
Posts: 18
Joined: Fri Mar 22, 2019 8:53 pm

Roth 401k or Traditional

Post by Boilermaker10 » Tue Aug 27, 2019 9:00 am

Hi,

My wife is starting a new job soon and has the option between a Roth 401k and traditional 401k. Wanted Bogle heads to weigh in on which makes sense for us.

Age:24/24
Combined income with her new job: 220k
Current tax bracket: 22%
Tax bracket in retirement: ? (Eventually expect large inheritance, parents net worth approx 10 mil, and growing)
Residence: Indiana (probably same in retirement)

Currently I contribute up to company match in traditional 401k (no Roth is offered, only to the match because of high fees)
I have been maxing both our Roth IRAs.
I also contribute to a SEP IRA as about 30k is self employment income.

My thoughts right now are to take advantage of the Roth 401k while tax rates are historically low. Also our income should climb, so if income/tax rates rise enough we can then switch to traditional. Still have plenty of time to build our after tax retirement accounts.

Current savings:
My Roth: 42k
Her Roth: 22k
My 401k:5k
Taxable investments:130k
Sep Ira: 10k
Savings: 25k

I assume conventional wisdom is also to max her 401k pending fees are reasonable?
Last edited by Boilermaker10 on Tue Aug 27, 2019 9:13 am, edited 1 time in total.

retiredjg
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Re: Roth 401k or Traditional

Post by retiredjg » Tue Aug 27, 2019 9:06 am

You might be in the 22% bracket this year, but I think you will only be in the 22% bracket next year if you each put $19k into tax-deferral.

Maybe Roth 401k would be ok for her this year (at 22%), but it should probably be traditional 401k after that. This is because it is very common for couples to be in a lower than 24% rate in retirement. An inheritance might change that.

Yes, she should max it if possible. You probably should too. Many people think they have "bad" 401k plans and at least half are wrong. You might want people here to look it over.

Admiral
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Re: Roth 401k or Traditional

Post by Admiral » Tue Aug 27, 2019 9:13 am

First, at age 24 I would ignore any potential inheritance unless the money is already in trust for your spouse. Wishful thinking can lead to poor investment decisions.

I would stick with Traditional 401k if it has low fees. Once you build up your nest egg some (and get a little older) you can then start contributing to Roth/taxable, or game out conversions once you see that A) the inheritance is actually going to happen and B) how it would be structured (like, is it Roth, is it taxable, is it Inherited IRA).

Unless you're projecting a future value of $10m (or are close to receiving it now), a $10m inheritance could be $30m or $0m in 20-30 years.
Last edited by Admiral on Tue Aug 27, 2019 9:32 am, edited 1 time in total.

Kagord
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Re: Roth 401k or Traditional

Post by Kagord » Tue Aug 27, 2019 9:22 am

+1 on inheritance advice, I was expecting, even was named in trust docs 30 years ago, with "your set, no need to ever worry about money". 3 marriages later, guess what happened, lol. Best advice, it's not your money, don't ever think that. Build your own path, which you are on your way to, apparently.
Last edited by Kagord on Tue Aug 27, 2019 9:25 am, edited 2 times in total.

Topic Author
Boilermaker10
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Joined: Fri Mar 22, 2019 8:53 pm

Re: Roth 401k or Traditional

Post by Boilermaker10 » Tue Aug 27, 2019 9:25 am

Over 50% of inheritance would be in farmland that has been passed down and expanded over generations in my family. Pretty confident it will be passed down at some point. Farmland will then throw off taxable cash (approx 2-5% of value depending on market conditions)

Admiral
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Re: Roth 401k or Traditional

Post by Admiral » Tue Aug 27, 2019 9:29 am

Boilermaker10 wrote:
Tue Aug 27, 2019 9:25 am
Over 50% of inheritance would be in farmland that has been passed down and expanded over generations in my family. Pretty confident it will be passed down at some point. Farmland will then throw off taxable cash (approx 2-5% of value depending on market conditions)
Two words: Climate Change. Ignore the inheritance. Or don't, at your peril.

It does nothing for you now and should have no impact on your investment decisions (based on your age). This topic has been covered many, many times here.

Topic Author
Boilermaker10
Posts: 18
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Re: Roth 401k or Traditional

Post by Boilermaker10 » Tue Aug 27, 2019 9:43 am

retiredjg wrote:
Tue Aug 27, 2019 9:06 am
You might be in the 22% bracket this year, but I think you will only be in the 22% bracket next year if you each put $19k into tax-deferral.

Maybe Roth 401k would be ok for her this year (at 22%), but it should probably be traditional 401k after that. This is because it is very common for couples to be in a lower than 24% rate in retirement. An inheritance might change that.

Yes, she should max it if possible. You probably should too. Many people think they have "bad" 401k plans and at least half are wrong. You might want people here to look it over.
401k fund fees are all between 1.2% and 2.3% (work at very small company, 50 employees). . Currently my contribution is 100% S and P 500 Index fund at 1.3% annual fee. All other investments are with vanguard in low fee funds.

Admiral
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Re: Roth 401k or Traditional

Post by Admiral » Tue Aug 27, 2019 9:50 am

Boilermaker10 wrote:
Tue Aug 27, 2019 9:43 am
retiredjg wrote:
Tue Aug 27, 2019 9:06 am
You might be in the 22% bracket this year, but I think you will only be in the 22% bracket next year if you each put $19k into tax-deferral.

Maybe Roth 401k would be ok for her this year (at 22%), but it should probably be traditional 401k after that. This is because it is very common for couples to be in a lower than 24% rate in retirement. An inheritance might change that.

Yes, she should max it if possible. You probably should too. Many people think they have "bad" 401k plans and at least half are wrong. You might want people here to look it over.
401k fund fees are all between 1.2% and 2.3% (work at very small company, 50 employees). . Currently my contribution is 100% S and P 500 Index fund at 1.3% annual fee. All other investments are with vanguard in low fee funds.
Ugg. That is horrible. I might only contribute up to the match and take by business elsewhere.

retiredjg
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Re: Roth 401k or Traditional

Post by retiredjg » Tue Aug 27, 2019 10:08 am

Boilermaker10 wrote:
Tue Aug 27, 2019 9:43 am
401k fund fees are all between 1.2% and 2.3% (work at very small company, 50 employees). . Currently my contribution is 100% S and P 500 Index fund at 1.3% annual fee. All other investments are with vanguard in low fee funds.
It's bad. Still worth using up to the match for sure. Probably even worth using (once you've filled everything else) for the tax deferral.

Kagord
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Re: Roth 401k or Traditional

Post by Kagord » Tue Aug 27, 2019 10:16 am

If you go excess over the employer match portion, you're saving 22% today. That might easily pay those fees until rollover time and then some.

Admiral
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Joined: Mon Oct 27, 2014 12:35 pm

Re: Roth 401k or Traditional

Post by Admiral » Tue Aug 27, 2019 10:24 am

Kagord wrote:
Tue Aug 27, 2019 10:16 am
If you go excess over the employer match portion, you're saving 22% today. That might easily pay those fees until rollover time and then some.
-1.2% compounded over 20-30 years?? :oops:

GAAP
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Re: Roth 401k or Traditional

Post by GAAP » Tue Aug 27, 2019 10:45 am

One other thing to consider -- current tax brackets expire in 2025, so if nothing else changes you will likely be in a 25% bracket. How much to plan (or not) around that likelihood has been a source of dissent around here in the past...
“Adapt what is useful, reject what is useless, and add what is specifically your own.” ― Bruce Lee

retiredjg
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Re: Roth 401k or Traditional

Post by retiredjg » Tue Aug 27, 2019 10:47 am

Most people don't stay 20 - 30 years. Or the plan is likely to improve before 20 - 30 years. It is not clear to me that contributing more than enough to get the match is necessarily a bad idea.

decapod10
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Re: Roth 401k or Traditional

Post by decapod10 » Tue Aug 27, 2019 10:51 am

Boilermaker10 wrote:
Tue Aug 27, 2019 9:43 am
retiredjg wrote:
Tue Aug 27, 2019 9:06 am
You might be in the 22% bracket this year, but I think you will only be in the 22% bracket next year if you each put $19k into tax-deferral.

Maybe Roth 401k would be ok for her this year (at 22%), but it should probably be traditional 401k after that. This is because it is very common for couples to be in a lower than 24% rate in retirement. An inheritance might change that.

Yes, she should max it if possible. You probably should too. Many people think they have "bad" 401k plans and at least half are wrong. You might want people here to look it over.
401k fund fees are all between 1.2% and 2.3% (work at very small company, 50 employees). . Currently my contribution is 100% S and P 500 Index fund at 1.3% annual fee. All other investments are with vanguard in low fee funds.
I don't suppose there is any chance of a mega-backdoor Roth IRA? If that was possible, I would do traditional 401k to the match, then mega-backdoor Roth IRA after that.

Topic Author
Boilermaker10
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Joined: Fri Mar 22, 2019 8:53 pm

Re: Roth 401k or Traditional

Post by Boilermaker10 » Tue Aug 27, 2019 10:57 am

Admiral wrote:
Tue Aug 27, 2019 10:24 am
Kagord wrote:
Tue Aug 27, 2019 10:16 am
If you go excess over the employer match portion, you're saving 22% today. That might easily pay those fees until rollover time and then some.
-1.2% compounded over 20-30 years?? :oops:
Probably won’t be at same place near that long. Can do an in service rollover and move money out of it, but I believe it was a $75 transfer fee. Consider doing that if/when there is enough money in it to justify the cost

DSInvestor
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Re: Roth 401k or Traditional

Post by DSInvestor » Tue Aug 27, 2019 11:02 am

If you're self employed and contributing 30K/yr to SEP-IRA, consider switching to Solo 401k. At your level of income, you may soon be ineligible for direct Roth IRA contributions which may have you considering the backdoor into Roth IRA (Traditional IRA contribution + Roth conversion). SEP-IRA assets are counted by form 8606 and will interfere with the backdoor into Roth IRA (forcing proration of IRA basis on Roth conversions). Solo 401k assets are not counted by form 8606 and will avoid IRA basis proration on Roth conversions.

Does your wife participate in your self employed business? If yes and she is paid a salary by the business, it would be possible for spouse to be added to the solo 401k plan which allows 19K employee salary deferral and thus avoid the high cost plan at her work place.

Solo 401k also allows for larger contributions than SEP-IRA. For example, if you're incorporated and have 120K salary, SEP-IRA allows for 30K contribution. Solo 401k would allow for 25% employer profit share (same as SEP) of 30K + 19K employee salary deferral for a total of 49K.

The solo 401k employee salary deferral limit of 19K is shared across all 401k plans for the person. If your wife contributes 6K to the work place plan to maximize her match, that leaves 13K that she can contribute to solo 401k employee salary deferral.
Wiki

Topic Author
Boilermaker10
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Re: Roth 401k or Traditional

Post by Boilermaker10 » Tue Aug 27, 2019 12:12 pm

DSInvestor wrote:
Tue Aug 27, 2019 11:02 am
If you're self employed and contributing 30K/yr to SEP-IRA, consider switching to Solo 401k. At your level of income, you may soon be ineligible for direct Roth IRA contributions which may have you considering the backdoor into Roth IRA (Traditional IRA contribution + Roth conversion). SEP-IRA assets are counted by form 8606 and will interfere with the backdoor into Roth IRA (forcing proration of IRA basis on Roth conversions). Solo 401k assets are not counted by form 8606 and will avoid IRA basis proration on Roth conversions.

Does your wife participate in your self employed business? If yes and she is paid a salary by the business, it would be possible for spouse to be added to the solo 401k plan which allows 19K employee salary deferral and thus avoid the high cost plan at her work place.

Solo 401k also allows for larger contributions than SEP-IRA. For example, if you're incorporated and have 120K salary, SEP-IRA allows for 30K contribution. Solo 401k would allow for 25% employer profit share (same as SEP) of 30K + 19K employee salary deferral for a total of 49K.

The solo 401k employee salary deferral limit of 19K is shared across all 401k plans for the person. If your wife contributes 6K to the work place plan to maximize her match, that leaves 13K that she can contribute to solo 401k employee salary deferral.
Sep is significantly easier to do than solo 401k. Sep is mine, wife does not have any tax deferred IRAs so could still do backdoor Roth’s in her name, just not in mine with SEP. She does not participate in the business

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Hector
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Re: Roth 401k or Traditional

Post by Hector » Tue Aug 27, 2019 12:17 pm

Admiral wrote:
Tue Aug 27, 2019 9:50 am
Boilermaker10 wrote:
Tue Aug 27, 2019 9:43 am
retiredjg wrote:
Tue Aug 27, 2019 9:06 am
You might be in the 22% bracket this year, but I think you will only be in the 22% bracket next year if you each put $19k into tax-deferral.

Maybe Roth 401k would be ok for her this year (at 22%), but it should probably be traditional 401k after that. This is because it is very common for couples to be in a lower than 24% rate in retirement. An inheritance might change that.

Yes, she should max it if possible. You probably should too. Many people think they have "bad" 401k plans and at least half are wrong. You might want people here to look it over.
401k fund fees are all between 1.2% and 2.3% (work at very small company, 50 employees). . Currently my contribution is 100% S and P 500 Index fund at 1.3% annual fee. All other investments are with vanguard in low fee funds.
Ugg. That is horrible. I might only contribute up to the match and take by business elsewhere.
Companies change 401k. People change job. I would try to max out unless I am sure that I am going to work at same company for few decades.

Kagord
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Re: Roth 401k or Traditional

Post by Kagord » Tue Aug 27, 2019 2:02 pm

Admiral wrote:
Tue Aug 27, 2019 10:24 am
Kagord wrote:
Tue Aug 27, 2019 10:16 am
If you go excess over the employer match portion, you're saving 22% today. That might easily pay those fees until rollover time and then some.
-1.2% compounded over 20-30 years?? :oops:
Not an oops, basic wealth building here. However, if your the charitable type, and you want your country to have more money and you have less wealth, sure, put it in after tax instead :happy

Admiral
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Re: Roth 401k or Traditional

Post by Admiral » Tue Aug 27, 2019 2:06 pm

Kagord wrote:
Tue Aug 27, 2019 2:02 pm
Admiral wrote:
Tue Aug 27, 2019 10:24 am
Kagord wrote:
Tue Aug 27, 2019 10:16 am
If you go excess over the employer match portion, you're saving 22% today. That might easily pay those fees until rollover time and then some.
-1.2% compounded over 20-30 years?? :oops:
Not an oops, basic wealth building here. However, if your the charitable type, and you want your country to have more money and you have less wealth, sure, put it in after tax instead :happy
I have no idea what that means but my point was it MAY be worth sucking up those high fees (and thus earning less over time) up to the employer match and then using another tax advantaged vehicle, if available, for any excess, assuming lower fees. That might be a Roth. >1% fees for an index fund is straight robbery.

Kagord
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Re: Roth 401k or Traditional

Post by Kagord » Tue Aug 27, 2019 2:08 pm

Agree,

401K to company match, IRA/HSA max (if you can, I'm AGI'd out), then max 401K, then taxable.

aristotelian
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Re: Roth 401k or Traditional

Post by aristotelian » Tue Aug 27, 2019 2:13 pm

Normally I would say max traditional 401k, but the inheritance could push you into a higher tax bracket, creating some uncertainty.

One way you could look at it is that if the inheritance pans out, you will have won the game. Who cares if you invest $19K suboptimally by going traditional? If something happens with the inheritance and it does not pan out, you will have a bit extra saved on taxes. If you invest all Roth and you don't receive the inheritance, then you will be doubly screwed. Going traditional at least avoids that outcome.

Alternatively, you could do some of each.

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TomatoTomahto
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Re: Roth 401k or Traditional

Post by TomatoTomahto » Tue Aug 27, 2019 2:19 pm

aristotelian wrote:
Tue Aug 27, 2019 2:13 pm
Normally I would say max traditional 401k, but the inheritance could push you into a higher tax bracket, creating some uncertainty.
One way you could look at it is that if the inheritance pans out, you will have won the game. Who cares if you invest $19K suboptimally by going traditional? If something happens with the inheritance and it does not pan out, you will have a bit extra saved on taxes. If you invest all Roth and you don't receive the inheritance, then you will be doubly screwed. Going traditional at least avoids that outcome.
Alternatively, you could do some of each.
Since the company match always goes to traditional, that’s one way to do some of each.
Okay, I get it; I won't be political or controversial. The Earth is flat.

aristotelian
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Re: Roth 401k or Traditional

Post by aristotelian » Tue Aug 27, 2019 2:45 pm

Admiral wrote:
Tue Aug 27, 2019 9:29 am
Boilermaker10 wrote:
Tue Aug 27, 2019 9:25 am
Over 50% of inheritance would be in farmland that has been passed down and expanded over generations in my family. Pretty confident it will be passed down at some point. Farmland will then throw off taxable cash (approx 2-5% of value depending on market conditions)
Two words: Climate Change. Ignore the inheritance. Or don't, at your peril.

It does nothing for you now and should have no impact on your investment decisions (based on your age). This topic has been covered many, many times here.
He is not talking about retirement or otherwise "counting on" the inheritance, just optimizing his finances for the most likely scenario. I would have no problem with them doing Roth in this case. I think inheritance is a factor in favor of Roth that is not often discussed.

Topic Author
Boilermaker10
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Re: Roth 401k or Traditional

Post by Boilermaker10 » Tue Aug 27, 2019 3:03 pm

TomatoTomahto wrote:
Tue Aug 27, 2019 2:19 pm
aristotelian wrote:
Tue Aug 27, 2019 2:13 pm
Normally I would say max traditional 401k, but the inheritance could push you into a higher tax bracket, creating some uncertainty.
One way you could look at it is that if the inheritance pans out, you will have won the game. Who cares if you invest $19K suboptimally by going traditional? If something happens with the inheritance and it does not pan out, you will have a bit extra saved on taxes. If you invest all Roth and you don't receive the inheritance, then you will be doubly screwed. Going traditional at least avoids that outcome.
Alternatively, you could do some of each.
Since the company match always goes to traditional, that’s one way to do some of each.
So we could do
Her Roth 401k: 18.5k
Her Trad 401k (employer match): 5k
My 401k: 7k
His and her Roth: 12k total
My SEP IRA: 6k

Total Traditional: 18k
Total Roth: 30.5k

We do not currently have access to an HSA but will use that if it becomes available.
Last edited by Boilermaker10 on Tue Aug 27, 2019 3:33 pm, edited 1 time in total.

DSInvestor
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Re: Roth 401k or Traditional

Post by DSInvestor » Tue Aug 27, 2019 3:16 pm

Boilermaker10 wrote:
Tue Aug 27, 2019 3:03 pm

I would just use my 401k to defer taxes and then rollover to IRA to get away from fees.
Unless you have a qualifying event (reaching retirement age, termination of employment, termination of plan etc), you cannot do a rollover of employee salary deferral contribution 401k assets to IRA. Some plans allow for in-service rollover of after tax contributions.
Wiki

Topic Author
Boilermaker10
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Re: Roth 401k or Traditional

Post by Boilermaker10 » Tue Aug 27, 2019 3:35 pm

DSInvestor wrote:
Tue Aug 27, 2019 3:16 pm
Boilermaker10 wrote:
Tue Aug 27, 2019 3:03 pm

I would just use my 401k to defer taxes and then rollover to IRA to get away from fees.
Unless you have a qualifying event (reaching retirement age, termination of employment, termination of plan etc), you cannot do a rollover of employee salary deferral contribution 401k assets to IRA. Some plans allow for in-service rollover of after tax contributions.
I apologize, you are correct, I did not realize it cannot be rolled. I edited it out of my post. Is it worth using anyway then even with the high fund fees? Alternative is saving in taxable....

retiredjg
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Re: Roth 401k or Traditional

Post by retiredjg » Tue Aug 27, 2019 3:38 pm

Boilermaker10 wrote:
Tue Aug 27, 2019 10:57 am
Probably won’t be at same place near that long. Can do an in service rollover and move money out of it, but I believe it was a $75 transfer fee. Consider doing that if/when there is enough money in it to justify the cost
You cannot roll out your elective deferrals (the $19k) until you leave that employer. That's law. If your plan says anything about an in-service rollover, that is something else and that something else might be worth looking into.

lakpr
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Re: Roth 401k or Traditional

Post by lakpr » Tue Aug 27, 2019 4:23 pm

I would not contribute to a 401k plan with a 1.2% expense ratio. Only up to the employer match, no more.

I have done an Excel based analysis with the following assumptions:

1. Invest $833 per month in 401k ($10k per year) with a 1.2% expense ratio
2. Invest $633 per month in taxable account ($7600 per year, after-tax equivalent of $10k) in a fund with expense ratio of 0.13% (typical Vanguard Target Date fund ER)
3. Market returns of 7% per year assumed in both cases
4. expense ratio is deducted from both investments straight off the bat before investing
5. dividend tax drag of 24% rate on 2% dividends per year assumed in the taxable account (basically assumes all taxable dividends are non-qualified).

The result is that, even with after-tax drag on dividends and capital gains, the taxable investment catches up with the 401k investment by month 40, and thereafter the taxable investment wins. After 10 years, the taxable investment is better off by $26k.

Unless you are sure to quit this job within the next 3 years, contributing to the 401k plan at such absurdly high expense ratios is not advisable.

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FiveK
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Re: Roth 401k or Traditional

Post by FiveK » Wed Aug 28, 2019 9:38 pm

lakpr wrote:
Tue Aug 27, 2019 4:23 pm
I would not contribute to a 401k plan with a 1.2% expense ratio. Only up to the employer match, no more.

I have done an Excel based analysis with the following assumptions:

1. Invest $833 per month in 401k ($10k per year) with a 1.2% expense ratio
2. Invest $633 per month in taxable account ($7600 per year, after-tax equivalent of $10k) in a fund with expense ratio of 0.13% (typical Vanguard Target Date fund ER)
3. Market returns of 7% per year assumed in both cases
4. expense ratio is deducted from both investments straight off the bat before investing
5. dividend tax drag of 24% rate on 2% dividends per year assumed in the taxable account (basically assumes all taxable dividends are non-qualified).

The result is that, even with after-tax drag on dividends and capital gains, the taxable investment catches up with the 401k investment by month 40, and thereafter the taxable investment wins. After 10 years, the taxable investment is better off by $26k.

Unless you are sure to quit this job within the next 3 years, contributing to the 401k plan at such absurdly high expense ratios is not advisable.
Even if one falls a bit behind while using a high fee 401k, rolling the 401k to a low fee tIRA upon separation allows it to catch and surpass the taxable account if the money can stay in the IRA for a while.

See either or both of the two spreadsheets mentioned in the [Wiki suggestion] Invest in taxable or 401(k)? thread, and the suggested way to evaluate expensive or mediocre 401k choices in that wiki article.

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