At what point is a 401k/403b/457b not worth it?

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AustenNut
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At what point is a 401k/403b/457b not worth it?

Post by AustenNut » Mon Jan 06, 2014 9:21 pm

In reading some threads (particularly about K-12 investment options), there seems to be a question of whether or not a 401k/403b/457b plan is so bad that it should be avoided, and a good taxable account should be set up instead. This is assuming that an IRA is already being fully used. My question is, what is that tipping point where the benefits of investing pretax money are outweighed by the costs of the specific plan? What factors are considered?

-Current tax rate?
-Expected tax rate as a retiree/pension?
-Front or back loads (usually in the 5% vicinity)?
-Expense ratios in excess of x%?
-Other factors I can't think of?

So, at what point is a plan's offerings so bad that it's better to invest in a taxable account?

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Re: At what point is a 401k/403b/457b not worth it?

Post by White Coat Investor » Mon Jan 06, 2014 9:23 pm

Around 2% per year last I ran the numbers, but that assumes you don't leave the job (and thus roll the money over) within a few years. If you can escape quickly, you can tolerate terrible funds and high expenses for a little while.
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Re: At what point is a 401k/403b/457b not worth it?

Post by columbia » Mon Jan 06, 2014 9:38 pm

Are you getting any level of matching funds from your employer?

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AustenNut
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Re: At what point is a 401k/403b/457b not worth it?

Post by AustenNut » Mon Jan 06, 2014 9:46 pm

I would go on the assumption that there are no employer matches, as most of the terrible plans I've read about have other benefits (like pensions).

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Re: At what point is a 401k/403b/457b not worth it?

Post by Peter Foley » Mon Jan 06, 2014 9:55 pm

For me it would be a couple of factors.
1. Employer match - up to the employer match if there is one. The match is likely to offset the higher fees.
2. Tax bracket - take advantage of the deferral if you are in the 25% bracket and the deferral will put you into the 15% bracket. Defer enough to put yourself comfortably into the 15% bracket, after which you can use a Roth or TIRA. If you are using actively managed funds in taxable and have long term capital gains and dividends every year, defer enough so that these gains and dividends will not be taxed.

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Re: At what point is a 401k/403b/457b not worth it?

Post by patrick » Mon Jan 06, 2014 10:27 pm

You'd need to work out the numbers for any specific case, but time is a huge factor. The longer you will be staying in the plan, the worse the fees are, by far. If you have a 2% expense ratio and plan to leave the job after 3 months it probably costs less than 2% even after account for a possible delay to process the withdrawal. On the other hand, it would cost more than 30% of your money if you leave it in the plan for 20 years. On the other hand, the longer the total time it stays tax-deferred (time in the plan plus time in the rollover IRA), the greater the tax deferral benefit is.

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Re: At what point is a 401k/403b/457b not worth it?

Post by White Coat Investor » Mon Jan 06, 2014 10:36 pm

The tax-deferral benefit of a 401K is easy to calculate. The tax arbitrage is a much bigger guess.

Consider investing in a Roth (to make the math easy) vs a taxable account for 30 years, 8% a year after expenses, then all the money withdrawn. Let's assume 15% LTC/dividends taxes on a 2% yield.

In the Roth, you end up with
=FV(8%,30,,-10000,1)= $100,627. That's basically an 8% return.

In the taxable, you end up with
=FV(7.7%,30,,-10000,1) =$92,570, then after capital gains taxes, $80,185. That's basically a return of 7.19%.

So the benefit of the tax deferral is 0.81% per year. If your expenses are higher than that, then you're better off in taxable than a Roth 401K. However, if it is a tax-deferred account, there is also the arbitrage to deal with, which is a more complex calculation, but suffice to say for the typical investor, you'd need expenses much higher than just 81 basis points.
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Re: At what point is a 401k/403b/457b not worth it?

Post by ajcp » Mon Jan 06, 2014 10:44 pm

EmergDoc wrote: However, if it is a tax-deferred account, there is also the arbitrage to deal with, which is a more complex calculation, but suffice to say for the typical investor, you'd need expenses much higher than just 81 basis points.
Can you explain what you mean by this?

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Re: At what point is a 401k/403b/457b not worth it?

Post by sschullo » Mon Jan 06, 2014 10:47 pm

Here is a calculator that gave me an estimate that fees over 1.2% makes the tax deferment moot. Check it out: http://public.sheet.zoho.com/public/the ... kortaxable
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Re: At what point is a 401k/403b/457b not worth it?

Post by harikaried » Mon Jan 06, 2014 10:48 pm

AustenNut wrote:-Other factors I can't think of?
If you can take a 401k loan, you can get the tax deferring of the 401k and expense ratio of your brokerage. You could even put the money towards a Roth IRA or 529 for more tax advantages over taxable brokerage accounts.

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Re: At what point is a 401k/403b/457b not worth it?

Post by AustenNut » Tue Jan 07, 2014 6:11 pm

Thank you, sschulo, for the link to that calculator. Unfortunately, some of the more technical explanations have gone over my head (though I'd be happy to receive further instruction). At least in my particular circumstances, the bad option is still better than the alternatives. Now I just need to lobby my employer for better ones!

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Re: At what point is a 401k/403b/457b not worth it?

Post by sschullo » Tue Jan 07, 2014 9:19 pm

AustenNut wrote:Thank you, sschulo, for the link to that calculator. Unfortunately, some of the more technical explanations have gone over my head (though I'd be happy to receive further instruction). At least in my particular circumstances, the bad option is still better than the alternatives. Now I just need to lobby my employer for better ones!
The bottom line is the Roth IRA is superior to any IRA. A good IRA has to have a low expense ratio, much less than 1.0%. Taxes and high expense ratio take away those gains.
It took me awhile to figure out how to use the calculator. I am not a math wiz, or an engineer, but just tinker with it and pay around with different assumptions.
Steve
Public School K-12 Educators: "Ask NOT what your annuity sales person can do for you, ask what you can do to be a Do-It-Yourselfer (DIY)."

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Re: At what point is a 401k/403b/457b not worth it?

Post by BradMajors » Tue Jan 07, 2014 9:23 pm

If you have no employer match and you intend to invest less than $5,500 you are always better off putting the money in an IRA instead.

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Re: At what point is a 401k/403b/457b not worth it?

Post by Watty » Tue Jan 07, 2014 9:35 pm

-Other factors I can't think of?
1) The earnings on the differed taxes might be enough to pay for the excessive expenses. For example if you a make a $100 contribution in the 25% tax bracket then you will have an extra $25 in the account. If that $25 earns 10% then you would earn an extra $2.50 the next year. If the excessive expenses are less then that then you came out ahead even though it will still really hurt you over the years compared to a low cost investment.

2) You might not have the money invested in the bad fund for more then a few years. You could leave the job, the company could get a better 401K, you might do an "in-service non-hardship withdrawal" at the age of 59.5, etc

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Re: At what point is a 401k/403b/457b not worth it?

Post by JohnDoh » Tue Jan 07, 2014 10:46 pm

Although variable annuities are generally sniffed at around here, there is now at least one very low cost variable annuity via Jefferson National (http://www.jeffnat.com) which charges a fixed $240 per year fee in addition to the ERs of the underlying investments. Although the vast bulk of their offerings will not appeal to a Boglehead, they do offer a sufficient variety of low-cost investments to satisfy basic Boglehead requirements, including investments from Vanguard and DFA. For portfolios of sufficient size, this can make sense as a vehicle for tax-inefficient holdings IMHO (especially if/when interest rates are higher).

In other words, one can fairly easily create one's own 401k/403b/457b (without the annual contribution limit, even) in lieu of a crappy plan offered by an employer if one wants. I'm not recommending this, but simply pointing it out.

Full disclosure: I have a VA at Jefferson National that I transferred from Vanguard a year or so ago. Originally my VA was devoted exclusively to REITs that I could not shelter elsewhere. REITs performed so well that over time that the VA now includes other things such as bonds.

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Re: At what point is a 401k/403b/457b not worth it?

Post by ashleytrailrunner » Thu Feb 12, 2015 11:34 am

I just started a new job with expensive 403(b) options that are held within a "Variable Group Annuity" account, and this discussion (as well as other discussions at Bogleheads.org) are very helpful. Like AustenNut, I'm trying to figure out if it's worth it to invest in this 403(b) or just open a taxable account at Vanguard.

I appreciate the calculator that sschullo posted earlier in this conversation, but do any of you know of an online calculator I could use that includes an option for employer contributions? This one https://docs.zoho.com/sheet/published.d ... 43fd7a923a doesn't have a field for that, and I'm not sure how to edit the sheet to include one.

My employer contributes 3% of my salary if I contribute 6%, but with an annual expense risk charge of 1.25%, quarterly fee of $7.50, and expense ratio of 1.04 for the cheapest broad-based stock fund they offer (American Funds AMCAP R3) that 3% diminishes pretty quickly. Then, once I leave the employer or retire, it looks like I can only move 20% out of the account per year, so whatever I choose, I'll be stuck with this variable annuity account for a long time.

Any chance a taxable account at Vanguard would be a better option in the long run? I already have a Roth IRA with Vanguard, which I max out every year, but obviously that alone is not enough to retire on.

Thanks in advance for any online calculators/other tools anyone can offer. I haven't been able to track one down.
-Ashley

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Re: At what point is a 401k/403b/457b not worth it?

Post by itstoomuch » Thu Feb 12, 2015 12:04 pm

Ans: when you have better uses for the funds. :idea:

Advised DS (30) not to contribute to 401k ( 28% marginal, Vanguard, no match) better off in taxable Vanguard and buying stocks. Has nothing to do with taxes or rates, but restrictions and lack of restrictions.
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Re: At what point is a 401k/403b/457b not worth it?

Post by sschullo » Thu Feb 12, 2015 12:26 pm

ashleytrailrunner wrote:I just started a new job with expensive 403(b) options that are held within a "Variable Group Annuity" account, and this discussion (as well as other discussions at Bogleheads.org) are very helpful. Like AustenNut, I'm trying to figure out if it's worth it to invest in this 403(b) or just open a taxable account at Vanguard.

I appreciate the calculator that sschullo posted earlier in this conversation, but do any of you know of an online calculator I could use that includes an option for employer contributions? This one https://docs.zoho.com/sheet/published.d ... 43fd7a923a doesn't have a field for that, and I'm not sure how to edit the sheet to include one.

My employer contributes 3% of my salary if I contribute 6%, but with an annual expense risk charge of 1.25%, quarterly fee of $7.50, and expense ratio of 1.04 for the cheapest broad-based stock fund they offer (American Funds AMCAP R3) that 3% diminishes pretty quickly. Then, once I leave the employer or retire, it looks like I can only move 20% out of the account per year, so whatever I choose, I'll be stuck with this variable annuity account for a long time.

Any chance a taxable account at Vanguard would be a better option in the long run? I already have a Roth IRA with Vanguard, which I max out every year, but obviously that alone is not enough to retire on.

Thanks in advance for any online calculators/other tools anyone can offer. I haven't been able to track one down.
-Ashley
Find out if your plan is under the ERISA requirements. If so, you might have some leverage to lower those costs. Here is the ERISA website, under the Department of Labor which oversees some 403(b), usually plans in which the employer offers a match. http://www.dol.gov/ebsa/403b.html
Public School K-12 Educators: "Ask NOT what your annuity sales person can do for you, ask what you can do to be a Do-It-Yourselfer (DIY)."

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Re: At what point is a 401k/403b/457b not worth it?

Post by ashleytrailrunner » Thu Feb 12, 2015 12:42 pm

Thanks, both of you!

Yes, there is an ERISA Section 404(c) statement in the enrollment packet, which reads:
The following transfer restriction will apply to monies in the Fixed Interest Account (FIA):
If you have $2,500 or more in the FIA at the beginning of the contract year, up to 20% of that amount may be transferred during that contract year.


That statement goes on to say that I have the right to request information relating to annual operating expenses, prospectuses, etc (which I requested and received -- which is why I'm so up in arms about all this!) but I don't see anything about having the right to invest with some other company.

The HR folks administering the plan for all of us don't seem concerned about how the fees eat into our returns. I shared what I thought were some pretty compelling comparisons between the return over time on high-fee plans vs lower-fee plans, and the HR folks' eyes just sort of glazed over.

Thanks so much for your advice. I'll delve deeper into the link you provided regarding ERISA.

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Re: At what point is a 401k/403b/457b not worth it?

Post by surfstar » Thu Feb 12, 2015 1:20 pm

Great thread with the links.

That calculator says I break even with taxable, if my 457b charges 1.1% on top of base ERs. I'm closer to 0.8 or so (cheapest index funds are .95), no match, but at least I know I'm still better off on filling that space. Roth is also max'd, of course. Plus the 457b will allow me to withdraw penalty-free at early retirement. I'm actually on the Committee and we're supposed to get pricing on Vanguard TR funds - probably .65 or more, but still would be our best option, if we can offer them.

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Re: At what point is a 401k/403b/457b not worth it?

Post by Garco » Thu Feb 12, 2015 1:47 pm

For 39 years, I had an employer match of 10% to my contribution of 5%. At that match rate (double my contribution) it was always "worth it." My hunch is it would have been worth it if the employer gave even 2%. On top of my 5% I also contributed to other tax deferred accounts, especially after kids finished college. So now I'm retired with a pretty good income source, including SS.

There's an intangible factor here: you ought to follow certain rules, which even is incentivized by even a small employer match. Namely, (1) ALWAYS contribute, from every paycheck. (2) NEVER borrow from your tax deferred accounts. Your final accumulation is going to depend very much on how many years you've been continuously reinvesting and compounding your savings. It's not just a matter of the annual rate of return.

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Re: At what point is a 401k/403b/457b not worth it?

Post by ashleytrailrunner » Thu Feb 12, 2015 1:56 pm

Wow, garco -- I wish my employer doubled my contribution!

I am guessing that the account limitations on the "group variable annuity contract" that my company's 403(b) plan resides within is going to make the determination about whether I participate or not. The more I read, the more dismayed I become: it looks like if I open this account I'll be saddled with it for life, as I can only withdraw or transfer 20% of the account balance per year.

If I could roll over the account balance to an IRA when I retire or change employers, I might risk it, and capture the 3% my employer will deposit. As it is, it just seems like the fees (annual, quarterly, ER & withdrawal charges) will eat up the account balance over time.

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