Increase 401K contributions vs start an IRA?

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Mode32
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Increase 401K contributions vs start an IRA?

Post by Mode32 »

Bogleheads,

Appreciate the advice you had given my sibling earlier who is starting out in their career and was looking for further insights on whether my sibling should increase 401K contributions vs start an IRA.

My sibling is already contributing past the employer match for 401K and is building a good EF. After expenses and savings for ear-marked purchases, my sibling consistently has extra money left over every month which they are looking to invest.

Savings rate is currently is 45% (401K and EF), and looking to invest 5% more. With that said, should my sibling increase 401K contributions (won't be able to max out, but can further increase contributions by 5%), or should they start an IRA (i.e., with Vanguard or Fidelity)? Of note, my sibling does not have access to HSA.

I am not really sure which is the best way forward (increase 401K contributions vs start an IRA), and would greatly appreciate your insights.

Thanks in advance.

Stay safe.
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Eagle33
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Re: Increase 401K contributions vs start an IRA?

Post by Eagle33 »

Rocket science is not “rocket science” to a rocket scientist, just as personal finance is not “rocket science” to a Boglehead.
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MNGopher
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Re: Increase 401K contributions vs start an IRA?

Post by MNGopher »

Go with which ever one has the lower cost funds.
lakpr
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Re: Increase 401K contributions vs start an IRA?

Post by lakpr »

What is your sibling's tax bracket? If in the 12% bracket, or even low 22% tax bracket, I would suggest Roth-401k + Roth-IRA, and invest everything in stocks. The 22% tax bracket is going to disappear (as the law stands currently) at the end of 2025, and your sibling could switch to Traditional 401k contributions at that time, and continue through to retirement.

If the salary places your sibling in high 22% bracket, though, I will withdraw that suggestion and push Traditional 401k instead.

If your sibling got job only very recently (say less than 2 months ago), it is very unlikely that he/she will cross over into the 22% tax bracket for 2020 at least, so for 2020 definitely do the Roth-401k + Roth-IRA.

A trick: Roth-401k does not reduce the income, so even if your sibling earned only $20k for the year, a contribution of $19.5k to Roth-401k will still report an AGI of $20k to IRS, which make a contribution of $6k to Roth-IRA possible (in effect saving $25.5k into retirement accounts on earnings of only $20k). Of course, to pull this off, your sibling should have other funds to live on during the year. Even if there aren't, it could be worthwhile to borrow for the remainder of the year (only 3 more months to go), and repay next year.
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Mode32
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Re: Increase 401K contributions vs start an IRA?

Post by Mode32 »

Eagle33 wrote: Sun Sep 13, 2020 8:15 pm Read wiki Prioritizing investments
Thanks for the link.

I don’t really understand the reasoning for the recommendation to maximize IRA (after contributions to EF and at least 401k match amount)...instead, why not increase 401k contributions even further before even starting or maximizing an IRA?

Is it because the assumption is that the 401K ER’s are higher and that one has more flexibility with IRA (i.e., almost like an EF if absolutely needed)?
Last edited by Mode32 on Sun Sep 13, 2020 10:28 pm, edited 1 time in total.
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Mode32
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Re: Increase 401K contributions vs start an IRA?

Post by Mode32 »

MNGopher wrote: Sun Sep 13, 2020 8:18 pm Go with which ever one has the lower cost funds.
Thanks! The 401k ER’s are also low cost; but I will compare.
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Mode32
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Re: Increase 401K contributions vs start an IRA?

Post by Mode32 »

lakpr wrote: Sun Sep 13, 2020 8:37 pm What is your sibling's tax bracket? If in the 12% bracket, or even low 22% tax bracket, I would suggest Roth-401k + Roth-IRA, and invest everything in stocks. The 22% tax bracket is going to disappear (as the law stands currently) at the end of 2025, and your sibling could switch to Traditional 401k contributions at that time, and continue through to retirement.

If the salary places your sibling in high 22% bracket, though, I will withdraw that suggestion and push Traditional 401k instead.

If your sibling got job only very recently (say less than 2 months ago), it is very unlikely that he/she will cross over into the 22% tax bracket for 2020 at least, so for 2020 definitely do the Roth-401k + Roth-IRA.

A trick: Roth-401k does not reduce the income, so even if your sibling earned only $20k for the year, a contribution of $19.5k to Roth-401k will still report an AGI of $20k to IRS, which make a contribution of $6k to Roth-IRA possible (in effect saving $25.5k into retirement accounts on earnings of only $20k). Of course, to pull this off, your sibling should have other funds to live on during the year. Even if there aren't, it could be worthwhile to borrow for the remainder of the year (only 3 more months to go), and repay next year.
Terrific insights and details that I wasn’t tracking; thank you!

I believe my sibling is in 22% tax bracket and I don’t think it’s on the higher end. The 401k does have a Roth option, so I will strongly recommend it. Still trying to figure out if my sibling should contribute more to 401k or start an IRA (while keeping same 401k contribution?
lakpr
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Re: Increase 401K contributions vs start an IRA?

Post by lakpr »

Mode32 wrote: Sun Sep 13, 2020 10:25 pm Still trying to figure out if my sibling should contribute more to 401k or start an IRA (while keeping same 401k contribution?
My recommendation is to maximize both. It is not an OR, it is an AND

Remember that, to be in a 22% tax bracket for 2020, your sibling should have earned at least $52k in 2020. If your sibling got the job in August, say, the starting salary offer should have been at least $52k * 12/5 = $125k (rounded slightly).

Unless your sibling's offer letter included higher salary than this, almost certainly it would be 12% bracket for 2020.

Try to maximize Roth 401k before end of December 31, as 401k contribution can only be made through paycheck. Ask the maximum percentage to be withheld from the paycheck. Roth IRA contribution can be made as late as April 15, 2021, so you have some time.

Re-emphasizing the importance of maximizing the contribution even at the cost of borrowing living expenses from elsewhere. The cost of borrowing will perhaps be 1 year worth of interest. Say a 10% loan (very high end, I assume there are credit unions your sibling can join and obtain a personal loan for less than that), which would be an expense of $2000 (10% of $19,500). But in return, the $19,500 contribution will enjoy 4 decades of tax free growth. A one time contribution of $19,500 growing at 6% CAGR over 40 years will result in $200k. Cost of $2k in interest expense, versus a return of $200k later, both in after-tax money and in today's dollars. Historically stocks averaged a return of 8%, and inflation averaged 2%, with a net real growth rate of 6%
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Mode32
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Re: Increase 401K contributions vs start an IRA?

Post by Mode32 »

lakpr wrote: Mon Sep 14, 2020 12:05 am
Mode32 wrote: Sun Sep 13, 2020 10:25 pm Still trying to figure out if my sibling should contribute more to 401k or start an IRA (while keeping same 401k contribution?
My recommendation is to maximize both. It is not an OR, it is an AND

Remember that, to be in a 22% tax bracket for 2020, your sibling should have earned at least $52k in 2020. If your sibling got the job in August, say, the starting salary offer should have been at least $52k * 12/5 = $125k (rounded slightly).

Unless your sibling's offer letter included higher salary than this, almost certainly it would be 12% bracket for 2020.

Try to maximize Roth 401k before end of December 31, as 401k contribution can only be made through paycheck. Ask the maximum percentage to be withheld from the paycheck. Roth IRA contribution can be made as late as April 15, 2021, so you have some time.

Re-emphasizing the importance of maximizing the contribution even at the cost of borrowing living expenses from elsewhere. The cost of borrowing will perhaps be 1 year worth of interest. Say a 10% loan (very high end, I assume there are credit unions your sibling can join and obtain a personal loan for less than that), which would be an expense of $2000 (10% of $19,500). But in return, the $19,500 contribution will enjoy 4 decades of tax free growth. A one time contribution of $19,500 growing at 6% CAGR over 40 years will result in $200k. Cost of $2k in interest expense, versus a return of $200k later, both in after-tax money and in today's dollars. Historically stocks averaged a return of 8%, and inflation averaged 2%, with a net real growth rate of 6%
Thank you for this extremely insightful perspective! I'm so appreciative of bogleheads like yourself for helping me see and understand the detail; again, the level of detail in your explanation is awesome and helps add clarity.

If I were my younger sibling, I would strive to max out both as well like you recommended esp with the details you laid out. However, I think trying to max out 401K and IRA will take a toll on her given current earnings as someone just starting out with their first job and learning to balance a budget. She is motivated to maintain a high monthly savings rate (about 50%) and wants to continue to save/invest consistently which I'm glad to hear.

At this time, if the choice is between increasing contributions to 401K vs starting an IRA for my sibling, what is the better move and why? (again, she is building an EF and does not have access to HSA).

Thanks for your time.
lakpr
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Re: Increase 401K contributions vs start an IRA?

Post by lakpr »

If you will frame the choice as a binary option like that, I would recommend Roth 401k. Primary reason for that recommendation is that the 401k plans offer unlimited creditor protections, whereas state laws govern the Roth-IRA. To be fair, 41 states do protect the IRAs on par with ERISA (the law that governs 401k plans and where the unlimited creditor protections come from), but are we sure that over the next 40 years your sibling will not move to a state that may not have such iron-clad protections? Why give up a valuable freebie?

The only knock against the Roth-401k vs. Roth-IRA is that the contributions to a Roth-IRA can be withdrawn in the future for any reason; and all withdrawals from Roth-IRA are assumed to be contributions first at the Federal level (state taxation differs; my home state, NJ, in particular treats non-qualified withdrawals from Roth-IRA as proportional withdrawal of contributions and growth, with taxes and penalties on growth portion. It's not unexpected that penalties and taxes are due to the state but none to Federal). But then I tend to view it (it = ability to withdraw from Roth account) as a negative, rather than a positive.

In addition, as I mentioned in my previous email, Roth-401k for now. There is time to contribute to a 2020 Roth IRA, until April-15, 2021. Roth-401k contribution cannot be made once Dec-31 passes.
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ruralavalon
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Re: Increase 401K contributions vs start an IRA?

Post by ruralavalon »

Mode32 wrote: Sun Sep 13, 2020 10:19 pm
Eagle33 wrote: Sun Sep 13, 2020 8:15 pm Read wiki Prioritizing investments
Thanks for the link.

I don’t really understand the reasoning for the recommendation to maximize IRA (after contributions to EF and at least 401k match amount)...instead, why not increase 401k contributions even further before even starting or maximizing an IRA?

Is it because the assumption is that the 401K ER’s are higher and that one has more flexibility with IRA (i.e., almost like an EF if absolutely needed)?
"If the company plan offers good, low-cost funds, it may be preferable to contribute to the company plan before contributing to an IRA." From the same wiki article.

What funds are offered in the 401k plan? Please give fund names, tickers and expense ratios.

Mode32 wrote: Mon Sep 14, 2020 10:36 amAt this time, if the choice is between increasing contributions to 401K vs starting an IRA for my sibling, what is the better move and why? (again, she is building an EF and does not have access to HSA).
If she is not able to do maximum annual contributions to both a 401k and an IRA, then the answer depends almost entirely on the funds offered in the 401k and their expense ratios.

If the funds and expense ratios in the 401k are about as good as she will get in an IRA, then the 401k does have the added benefit of automatic deductions from payroll, which makes budget discipline easier.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started
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Mode32
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Re: Increase 401K contributions vs start an IRA?

Post by Mode32 »

lakpr wrote: Mon Sep 14, 2020 12:03 pm If you will frame the choice as a binary option like that, I would recommend Roth 401k. Primary reason for that recommendation is that the 401k plans offer unlimited creditor protections, whereas state laws govern the Roth-IRA. To be fair, 41 states do protect the IRAs on par with ERISA (the law that governs 401k plans and where the unlimited creditor protections come from), but are we sure that over the next 40 years your sibling will not move to a state that may not have such iron-clad protections? Why give up a valuable freebie?

The only knock against the Roth-401k vs. Roth-IRA is that the contributions to a Roth-IRA can be withdrawn in the future for any reason; and all withdrawals from Roth-IRA are assumed to be contributions first at the Federal level (state taxation differs; my home state, NJ, in particular treats non-qualified withdrawals from Roth-IRA as proportional withdrawal of contributions and growth, with taxes and penalties on growth portion. It's not unexpected that penalties and taxes are due to the state but none to Federal). But then I tend to view it (it = ability to withdraw from Roth account) as a negative, rather than a positive.

In addition, as I mentioned in my previous email, Roth-401k for now. There is time to contribute to a 2020 Roth IRA, until April-15, 2021. Roth-401k contribution cannot be made once Dec-31 passes.
Appreciate the advice and the reasoning. After discussing this with my sibling, she now plans to increase her Roth 401K contributions significantly and will start an IRA with small regular contributions for now. Thanks!

She won't be able to start with admiral shares of VTSAX for her IRA, so I was thinking of advising her to use ETF version (i.e. VTI with ER .03) given similar ER's to VTSAX and mirrored performance (instead of going for investor share with higher ER..ie, .14). I don't have much experience with ETF's at all, so had a few questions:

1. Can you easily convert VTI to VTSAX once $3K minimum is reached?
2. If VTI was held in a taxable brokerage account, can you still make the conversion from VTI to VTSAX once $3K minimum is reached without any tax consequences (capital gains..etc)?
3. When purchasing an ETF like VTI, does the purchase price result from the moment you place the order, or can you simply get the purchase price at the end of the day like one would for VTSAX?
4. Can one tap Roth IRA contributions without any penalty...and is there a time limit the contribution has to be in the account before one can use Roth IRA? (I agree, utilizing Roth IRA is not ideal, but just want to get a better understanding of what Roth IRA offers).

Not sure if I need to start a new thread. Thanks for your time.
Last edited by Mode32 on Tue Sep 15, 2020 2:23 pm, edited 2 times in total.
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Mode32
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Re: Increase 401K contributions vs start an IRA?

Post by Mode32 »

ruralavalon wrote: Mon Sep 14, 2020 6:21 pm
Mode32 wrote: Sun Sep 13, 2020 10:19 pm
Eagle33 wrote: Sun Sep 13, 2020 8:15 pm Read wiki Prioritizing investments
Thanks for the link.

I don’t really understand the reasoning for the recommendation to maximize IRA (after contributions to EF and at least 401k match amount)...instead, why not increase 401k contributions even further before even starting or maximizing an IRA?

Is it because the assumption is that the 401K ER’s are higher and that one has more flexibility with IRA (i.e., almost like an EF if absolutely needed)?
"If the company plan offers good, low-cost funds, it may be preferable to contribute to the company plan before contributing to an IRA." From the same wiki article.

What funds are offered in the 401k plan? Please give fund names, tickers and expense ratios.

Mode32 wrote: Mon Sep 14, 2020 10:36 amAt this time, if the choice is between increasing contributions to 401K vs starting an IRA for my sibling, what is the better move and why? (again, she is building an EF and does not have access to HSA).
If she is not able to do maximum annual contributions to both a 401k and an IRA, then the answer depends almost entirely on the funds offered in the 401k and their expense ratios.

If the funds and expense ratios in the 401k are about as good as she will get in an IRA, then the 401k does have the added benefit of automatic deductions from payroll, which makes budget discipline easier.
Thank you for clearing that up for me! My sibling's 401K has an S&P500 index fund (ER .02) so will be going with that. She is thinking about purchasing VTI for IRA, but I had asked some questions (above) about ETF which may change how she want's to split her contributions.

Thank you very much for your insights and time!
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Re: Increase 401K contributions vs start an IRA?

Post by Watty »

Mode32 wrote: Sun Sep 13, 2020 8:10 pm .....would greatly appreciate your insights.
Something to keep in mind is that there can be a lot of financial goals other than retirement. For example;

1) Save up the downpayment for a house
2) save up to pay cash when you need your next car
3) College savings for kids
4) Build up a larger emergency fund

etc.

It very well could be that he or she may want to focus on one of these goals instead of contributing to a retirement plan.

That said, then as long as it has reasonably low expenses then the 401k plan has a huge advantage in that increasing the contributions to it are very easy to do so the extra savings actually get done with every pay check. Lot so people plan on making an IRA or Roth contribution but it never gets done.

Depending on their income contributing to a deductible IRA might not even be an option.

https://www.irs.gov/retirement-plans/ir ... ion-limits

Someone mention that a Roth might make sense. Given that you did not mention a spouse in your post I would assume that they are single now. That makes a Roth a lot harder to justify when you could make a deductible IRA or 401k contribution. The problem is that single people get into the higher tax brackets real quick but he or she might me married when they are retired and in the lower joint tax brackets then. It is not impossible but if they are single then it would take a real compelling situation to choose a Roth over a deductible 401k contribution when they are even in the 12% federal tax bracket.
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Re: Increase 401K contributions vs start an IRA?

Post by ruralavalon »

Mode32 wrote: Tue Sep 15, 2020 1:59 pm
lakpr wrote: Mon Sep 14, 2020 12:03 pm If you will frame the choice as a binary option like that, I would recommend Roth 401k. Primary reason for that recommendation is that the 401k plans offer unlimited creditor protections, whereas state laws govern the Roth-IRA. To be fair, 41 states do protect the IRAs on par with ERISA (the law that governs 401k plans and where the unlimited creditor protections come from), but are we sure that over the next 40 years your sibling will not move to a state that may not have such iron-clad protections? Why give up a valuable freebie?

The only knock against the Roth-401k vs. Roth-IRA is that the contributions to a Roth-IRA can be withdrawn in the future for any reason; and all withdrawals from Roth-IRA are assumed to be contributions first at the Federal level (state taxation differs; my home state, NJ, in particular treats non-qualified withdrawals from Roth-IRA as proportional withdrawal of contributions and growth, with taxes and penalties on growth portion. It's not unexpected that penalties and taxes are due to the state but none to Federal). But then I tend to view it (it = ability to withdraw from Roth account) as a negative, rather than a positive.

In addition, as I mentioned in my previous email, Roth-401k for now. There is time to contribute to a 2020 Roth IRA, until April-15, 2021. Roth-401k contribution cannot be made once Dec-31 passes.
Appreciate the advice and the reasoning. After discussing this with my sibling, she now plans to increase her Roth 401K contributions significantly and will start an IRA with small regular contributions for now. Thanks!

She won't be able to start with admiral shares of VTSAX for her IRA, so I was thinking of advising her to use ETF version (i.e. VTI with ER .03) given similar ER's to VTSAX and mirrored performance (instead of going for investor share with higher ER..ie, .14). I don't have much experience with ETF's at all, so had a few questions:

1. Can you easily convert VTI to VTSAX once $3K minimum is reached?
Yes.

Mode32 wrote: Tue Sep 15, 2020 1:59 pm2. If VTI was held in a taxable brokerage account, can you still make the conversion from VTI to VTSAX once $3K minimum is reached without any tax consequences (capital gains..etc)?
No. In a regular taxable account the ETF to fund transaction is a taxable event.

Vanguard FAQ, "Can I convert . . . ." . "Keep in mind that you can't convert ETF Shares back to conventional shares. If you decide in the future to sell your Vanguard ETF Shares and repurchase conventional shares, that transaction could be taxable."


Mode32 wrote: Tue Sep 15, 2020 1:59 pm3. When purchasing an ETF like VTI, does the purchase price result from the moment you place the order, or can you simply get the purchase price at the end of the day like one would for VTSAX?
For an ETF you get the intra-day price at the time the transaction occurs, not the NAV at end of the trading day.



Mode32 wrote: Tue Sep 15, 2020 1:59 pm4. Can one tap Roth IRA contributions without any penalty...and is there a time limit the contribution has to be in the account before one can use Roth IRA? (I agree, utilizing Roth IRA is not ideal, but just want to get a better understanding of what Roth IRA offers).
Wiki article, Roth IRA, "Distributions" . "Regular Contributions can be withdrawn at any time with no tax and no penalty."

Investopedia, "Roth IRA Withdrawal Rules". "You can withdraw your Roth IRA contributions at any time, for any reason, with no tax or penalties."


Mode32 wrote: Tue Sep 15, 2020 1:59 pmNot sure if I need to start a new thread. Thanks for your time.
It's usually best to keep all questions about an investor's portfolio in a single thread.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started
lakpr
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Re: Increase 401K contributions vs start an IRA?

Post by lakpr »

Mode32 wrote: Tue Sep 15, 2020 1:59 pm 1. Can you easily convert VTI to VTSAX once $3K minimum is reached?
2. If VTI was held in a taxable brokerage account, can you still make the conversion from VTI to VTSAX once $3K minimum is reached without any tax consequences (capital gains..etc)?
3. When purchasing an ETF like VTI, does the purchase price result from the moment you place the order, or can you simply get the purchase price at the end of the day like one would for VTSAX?
4. Can one tap Roth IRA contributions without any penalty...and is there a time limit the contribution has to be in the account before one can use Roth IRA? (I agree, utilizing Roth IRA is not ideal, but just want to get a better understanding of what Roth IRA offers).

Not sure if I need to start a new thread. Thanks for your time.
Perhaps consider Fidelity as the home of her Roth IRA instead of Vanguard. Fidelity's index funds start with a minimum of $1. Their mutual funds also have lower expense ratio than even Vanguard (FSKAX, Fidelity Total Stock Market Index fund, for example, has 0.015% ER, whereas VTSAX has 0.04%). And of course, if you are open to consider Fidelity, you have their Zero lineup of funds too!

I tend to prefer mutual funds than ETFs, since ETFs trade like a stock; and just like stocks, you can find yourself on the wrong end of the comparison with respect to end-of-day price (of course, equally likely that you will find yourself on the right end of that comparison too). But I'd rather prefer the certainty that, whether I deposit $1 in the morning at 9:00 AM or in the evening at 3:50 PM just before close, I will always be assured of buying a fixed number of shares that my $1 buys. No deviation.

As has been answered already, VTI --> VTSAX conversion is a taxable event, if done in a taxable account. But if you are doing this in a Roth IRA, no tax implications.

No time limit for the "direct contributions" to be taken out of the Roth IRA account. You can deposit today, and remove it tomorrow, no worries. Roth *conversions* on the other hand, must stay in the account for at least 5 years, and even when you withdraw them later, the earnings on that converted portion are assumed to come out first (and therefore taxes and penalties). Of course, refer to the Wiki article linked above by @ruralavalon.
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Mode32
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Re: Increase 401K contributions vs start an IRA?

Post by Mode32 »

Watty wrote: Tue Sep 15, 2020 3:17 pm
Mode32 wrote: Sun Sep 13, 2020 8:10 pm .....would greatly appreciate your insights.
Something to keep in mind is that there can be a lot of financial goals other than retirement. For example;

1) Save up the downpayment for a house
2) save up to pay cash when you need your next car
3) College savings for kids
4) Build up a larger emergency fund

etc.

It very well could be that he or she may want to focus on one of these goals instead of contributing to a retirement plan.
Very true; it's a fine balance. This is the first time my sibling is starting a job as a young adult and although she understands the value of investing for retirement early, I'm sure there are other goals she may be saving for as well. I'm very appreciative of the things I gained from the boglehead community in relation to finances which has helped me. Even though she has limited interest in finances, she wants to invest/save the right way. Thank you!
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Watty
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Re: Increase 401K contributions vs start an IRA?

Post by Watty »

Mode32 wrote: Tue Sep 15, 2020 5:18 pm This is the first time my sibling is starting a job as a young adult and although she understands the value of investing for retirement early, I'm sure there are other goals she may be saving for as well.
One thing I did when I was in my 30s is that I committed to myself to put half of any future raises into my 401k. I managed to do that for a long time and that made it painless to increase my retirement savings because I never got used to having the extra money when I got a raise.
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Re: Increase 401K contributions vs start an IRA?

Post by KlangFool »

OP,


She can put her EF into the Roth IRA.

https://www.bogleheads.org/wiki/Roth_IR ... gency_fund


KlangFool
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Mode32
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Re: Increase 401K contributions vs start an IRA?

Post by Mode32 »

@ ruralavalon and lakpr:

Thanks for the details.

Ideally, we wanted to start an IRA and a brokerage acct for my sibling with the same firm (Vanguard or Fidelity).

With the taxable acct, I struggle with deciding between VTI (with Vanguard) vs. FSKAX (with Fidelity). I want the tax efficiency of ETF, but don't like the mechanics of buying/selling ETF's compared to VTSAX. My understanding is that FSKAX isn't as tax efficient as VTSAX (some proprietary function of Vanguard funds).

1. How much less tax efficient is FSKAX compared to VTSAX...is it a meaningful amount over time that justifies avoiding it in a taxable if possible?
2. I don't own ETF's, but I also don't want to saddle my sibling with a product that may be more complicated to use...please call me out if I'm overthinking this.

Thanks for your time and wisdom.
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Re: Increase 401K contributions vs start an IRA?

Post by lakpr »

Mode32 wrote: Tue Sep 15, 2020 5:50 pm @ ruralavalon and lakpr:

Thanks for the details.

Ideally, we wanted to start an IRA and a brokerage acct for my sibling with the same firm (Vanguard or Fidelity).

With the taxable acct, I struggle with deciding between VTI (with Vanguard) vs. FSKAX (with Fidelity). I want the tax efficiency of ETF, but don't like the mechanics of buying/selling ETF's compared to VTSAX. My understanding is that FSKAX isn't as tax efficient as VTSAX (some proprietary function of Vanguard funds).

1. How much less tax efficient is FSKAX compared to VTSAX...is it a meaningful amount over time that justifies avoiding it in a taxable if possible?
2. I don't own ETF's, but I also don't want to saddle my sibling with a product that may be more complicated to use...please call me out if I'm overthinking this.

Thanks for your time and wisdom.
You can buy VTI, if that's what you wish, at Fidelity for no additional transaction costs.

Or, alternatively, you can buy FSKAX while having a Brokerage platform at Vanguard (but unlike Fidelity, the minimum you have to cough up is $1000) for no additional transaction costs.

I don't have a Fidelity account, but I think I heard on this forum that Fidelity charges $75 per purchase of Vanguard funds.

So you do have alternatives of buying Vanguard funds at Fidelity (perhaps ETFs) or Fidelity funds at Vanguard (higher minimums).

I realize this is NOT answering the tax-efficiency question in your post, but that's because no one can predict what that would be. Tax-efficiency comes into picture for a mutual fund only if the fund itself sells stocks. Typically, such sale of stocks by a fund, especially an index fund, happens if one of the firms is bought out (example: Monsanto's buyout by Bayer). Vanguard has a patent that expires at the end of 2023 that minimizes such capital gains distributions to the shareholders, but other firms are stuck, by law, to distribute those gains -- and therefore the shareholder will incur tax.

With only 3 more years to go for the patent's life, I expect everyone will start copying the technique afterwards. So the so-called headache of tax-efficiency might be only for 3 more years.
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Re: Increase 401K contributions vs start an IRA?

Post by ruralavalon »

Mode32 wrote: Tue Sep 15, 2020 5:50 pm @ ruralavalon and lakpr:

Thanks for the details.

Ideally, we wanted to start an IRA and a brokerage acct for my sibling with the same firm (Vanguard or Fidelity).

With the taxable acct, I struggle with deciding between VTI (with Vanguard) vs. FSKAX (with Fidelity). I want the tax efficiency of ETF, but don't like the mechanics of buying/selling ETF's compared to VTSAX. My understanding is that FSKAX isn't as tax efficient as VTSAX (some proprietary function of Vanguard funds).

1. How much less tax efficient is FSKAX compared to VTSAX...is it a meaningful amount over time that justifies avoiding it in a taxable if possible?
2. I don't own ETF's, but I also don't want to saddle my sibling with a product that may be more complicated to use...please call me out if I'm overthinking this.

Thanks for your time and wisdom.
I agree that it's convenient to have all accounts a just one fund firm. Both Vanguard and Fidelity are good choices, it's largely a matter of personal preference. My personal preference is Vanguard.

Vanguard offers a much broader selection of low expense mutual funds, even the actively managed funds have low expense ratios. In addition to their own ETFs Vanguard offers commission free trades in over 3800 ETFs of other companies (including BlackRock, Fidelity, PIMCO, Schwab, State Street).

1. The idea is buy and hold investing, so trading mechanics are less important than they might seem. Holding Vanguard Total Stock Market ETF (VTI) in an account with Vanguard she can have automatic reinvestment of dividends.

2. I don't know an easy way to quantify the tax advantage of Vanguard Total Stock Market ETF (VTI), it depends on her tax bracket and will vary from year to year depending on the percentage of dividends which are qualified dividends.
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Topic Author
Mode32
Posts: 182
Joined: Mon Mar 02, 2020 1:24 pm

Re: Increase 401K contributions vs start an IRA?

Post by Mode32 »

My sibling decided to go with Fidelity for her IRA (she wants to think some more about where to put brokerage).

I'm mainly with Vanguard, so I don't know the Fidelity funds that well. I was going to recommend FXAIX (S&P 500 Index fund; ER .015), but noticed they offered FNILX (Fidelity Zero Large Cap Index fund; ER 0). Looking at the two funds, they seem to hold the same companies; however, the benchmark indexes, % turnover, and YTD performance are difference (FNILX higher).

I understand that YTD/short-term performances mean nothing (and past performance doesn't mean future performance), but interesting to see how two similar funds performed during this downturn.

1. Is the performance different explained by ER difference?
2. Comparing FXAIX (which I used to think was the "go to" passively managed index fund at Fidelity) to FNILX, it seems like a no brainer to go with FNILX for a tax-advantaged account...but, am I missing something; whats the catch? (FNILX has higher % turnover, so assuming less tax-efficient...so not as ideal for taxable acct compared to FXIAX)
3. How are two similar funds following different benchmarks?

Thanks for your time and thoughts.

*Edit: 4. With a Fidelity IRA, are you able to buy fractional shares of mutual funds?
Last edited by Mode32 on Wed Sep 16, 2020 6:31 pm, edited 2 times in total.
Topic Author
Mode32
Posts: 182
Joined: Mon Mar 02, 2020 1:24 pm

Re: Increase 401K contributions vs start an IRA?

Post by Mode32 »

lakpr wrote: Tue Sep 15, 2020 6:25 pm
Mode32 wrote: Tue Sep 15, 2020 5:50 pm @ ruralavalon and lakpr:

Thanks for the details.

Ideally, we wanted to start an IRA and a brokerage acct for my sibling with the same firm (Vanguard or Fidelity).

With the taxable acct, I struggle with deciding between VTI (with Vanguard) vs. FSKAX (with Fidelity). I want the tax efficiency of ETF, but don't like the mechanics of buying/selling ETF's compared to VTSAX. My understanding is that FSKAX isn't as tax efficient as VTSAX (some proprietary function of Vanguard funds).

1. How much less tax efficient is FSKAX compared to VTSAX...is it a meaningful amount over time that justifies avoiding it in a taxable if possible?
2. I don't own ETF's, but I also don't want to saddle my sibling with a product that may be more complicated to use...please call me out if I'm overthinking this.

Thanks for your time and wisdom.
You can buy VTI, if that's what you wish, at Fidelity for no additional transaction costs.

Or, alternatively, you can buy FSKAX while having a Brokerage platform at Vanguard (but unlike Fidelity, the minimum you have to cough up is $1000) for no additional transaction costs.

I don't have a Fidelity account, but I think I heard on this forum that Fidelity charges $75 per purchase of Vanguard funds.

So you do have alternatives of buying Vanguard funds at Fidelity (perhaps ETFs) or Fidelity funds at Vanguard (higher minimums).

I realize this is NOT answering the tax-efficiency question in your post, but that's because no one can predict what that would be. Tax-efficiency comes into picture for a mutual fund only if the fund itself sells stocks. Typically, such sale of stocks by a fund, especially an index fund, happens if one of the firms is bought out (example: Monsanto's buyout by Bayer). Vanguard has a patent that expires at the end of 2023 that minimizes such capital gains distributions to the shareholders, but other firms are stuck, by law, to distribute those gains -- and therefore the shareholder will incur tax.

With only 3 more years to go for the patent's life, I expect everyone will start copying the technique afterwards. So the so-called headache of tax-efficiency might be only for 3 more years.
Very interesting to learn about Vanguard's patent; almost think it will become an industry standard. As posted above, my sibling decided to go with Fidelity for IRA, and wants to think some more about the taxable acct. She wanted to stay away from ETF's probably because I wasn't familiar with it which I told her was not a good reason. Nevertheless, I see a person starting to ask questions about investing which is a 180 from several weeks ago :). As always, thank you for your keen insights.
Topic Author
Mode32
Posts: 182
Joined: Mon Mar 02, 2020 1:24 pm

Re: Increase 401K contributions vs start an IRA?

Post by Mode32 »

ruralavalon wrote: Wed Sep 16, 2020 10:17 am
Mode32 wrote: Tue Sep 15, 2020 5:50 pm @ ruralavalon and lakpr:

Thanks for the details.

Ideally, we wanted to start an IRA and a brokerage acct for my sibling with the same firm (Vanguard or Fidelity).

With the taxable acct, I struggle with deciding between VTI (with Vanguard) vs. FSKAX (with Fidelity). I want the tax efficiency of ETF, but don't like the mechanics of buying/selling ETF's compared to VTSAX. My understanding is that FSKAX isn't as tax efficient as VTSAX (some proprietary function of Vanguard funds).

1. How much less tax efficient is FSKAX compared to VTSAX...is it a meaningful amount over time that justifies avoiding it in a taxable if possible?
2. I don't own ETF's, but I also don't want to saddle my sibling with a product that may be more complicated to use...please call me out if I'm overthinking this.

Thanks for your time and wisdom.
I agree that it's convenient to have all accounts a just one fund firm. Both Vanguard and Fidelity are good choices, it's largely a matter of personal preference. My personal preference is Vanguard.

Vanguard offers a much broader selection of low expense mutual funds, even the actively managed funds have low expense ratios. In addition to their own ETFs Vanguard offers commission free trades in over 3800 ETFs of other companies (including BlackRock, Fidelity, PIMCO, Schwab, State Street).

1. The idea is buy and hold investing, so trading mechanics are less important than they might seem. Holding Vanguard Total Stock Market ETF (VTI) in an account with Vanguard she can have automatic reinvestment of dividends.

2. I don't know an easy way to quantify the tax advantage of Vanguard Total Stock Market ETF (VTI), it depends on her tax bracket and will vary from year to year depending on the percentage of dividends which are qualified dividends.
Agree, having everything under one roof makes it much easier. She decided on Fidelity for her IRA; but, wants to think some more about the placement of the taxable account. Appreciate your time and ability to share investment knowledge; thank you!
softwaregeek
Posts: 526
Joined: Wed May 08, 2019 8:59 pm

Re: Increase 401K contributions vs start an IRA?

Post by softwaregeek »

Agree with others above but I would note that IRA balances can be used at some institutions to meet balance tier requirements. For example, at large banks it gets mortgage and credit card benefits.
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