Cite?
This isn’t necessarily true. It is true that 401(k) plans typically incur administrative expenses that an individual IRA wouldn’t. However, it is often the case that in a 401(k) plan you will be investing in institutional or retirement classes of mutual funds that have lower expense ratios than the classes of funds you would have access to in your IRA. And if you work for one of the ever shrinking number of employers that pay the administrative expenses of the 401(k) plan out of their pocket instead of out of the plan’s pocket, the 401(k) option is even less expensive for you.
I disagree, It should be the first account funded for a homeowner starting a new job. Better to cash a Roth than lose a house. Many people in this economy have been forced to cash a 401K and THAT is painful. Instead of getting 100% of their principle they get 60%. The rest is gone. Forever.
It’s an extra 10% penalty. That’s all. Sure, taking the cash out is taxable, but usually when you are desperate like that you’re in a lower tax bracket anyway.
It’s 10% on top of the tax rate. The principle in a Roth comes out with no tax so in an emergency it’s going to be roughly 40% of a 401K because the principal has not been taxed yet versus zero with a Roth which has already been taxed.
It’s a function of financial planning against future loss. When starting a new job a person is usually the first person laid off when things go south. The strategy changes over time. When a house is involved then people should invest with a strategy to maintain the greatest amount of net worth as possible. Losing a house, particularly in a housing bubble collapse, is a significant loss of net worth.
It may make sense to charge the loss of home value back to the bank in a foreclosure but that destroys credit which is often looked at by potential employers.
It does depend to some extent on your investing approach, and if you are foolish enough to invest in actively managed funds, then 401(k)s may offer slightly cheaper classes. But if you open your IRA with a low-cost provider such as Vanguard or Fidelity and stick to investing in index funds (thereby beating 70 - 90% of actively managed funds over 25 years, depending on how many funds you have - the more you have the less likely you are to beat indexing), that will be significantly cheaper than any 401(k).
Large company 401(k)s are not too horrendous, with total fees typically in the 1 - 1.5% per annum range. Small company plans can be 2 - over 3% With an IRA you should be able to keep fees at about 0.2% The difference a 1 - 2% saving makes over 20 - 30 years is huge.
I recently analyzed my wife’s 401(k) and even though it looks to be better than average, I still calculated that over half of the tax benefits were going in extra fees to the 401(k) administrator and provider. There was a 0.45% asset fee, which you would not have to pay in an IRA, to pay the administrators. The fund providers only offer expensive funds - for an S&P 500 index fund they only offered their own fund, with an expense ratio of 0.8% compared with Vanguard’s 0.18% Most of the other funds had expense ratios over 1% - they offer expensive funds because they get paid back by the fund company out of these fees. They do offer some less expensive funds through what they call a “fund window”, which allows access to some cheaper funds, but then they charge an extra 0.38% to make up for the fact that they don’t get paid marketing fees on these funds.
Google “401(k) fees” and you will find plenty of articles about excessive fees and how difficult it is to find out how much you are actually being charged. You can look up your own plan at www.brightscope.com and they will show you where your plan stands compared to the average (but does not include any hard and fast numbers).
I started my Roth IRA when I was in grad school. I plan on being taxed a bit more during retirement than I was then.
The Federal Income Tax Rate started out with a low bracket of 1% and a high bracket of 7%, and is now at 10% and 35% respectively. Wikipedia
Social Security taxes started at 1% each for employer and employee, and are now 7.65% each SocialSecurity.gov.
I can’t find historical rates for CA (where I live), but I know it’s been increased at least once in the last few years.
Do you have any evidence that tax rates don’t tend to increase over time?
People with 401k distributions, in my practice anyway, tend to have HIGHER taxable incomes.
Let’s say you need $100k each year to get by. You lose your job, etc. and are now 40k short. To get $40k in cash out of your 401k, you take $50k, with 20% withheld for taxes. Now you have taxable income of $110k. Oh, and you owe more tax than you thought because the 20% withholding was not even enough for the income tax.
Compare that to tapping a Roth, and you see that you’d have only had taxable income of $60k, and that you’d only have to take out $40k to get $40k in cash.
(That said, I’m not convinced that tapping retirement assets to save a house is a smart thing to do. Retirement assets are protected by bankruptcy laws. Better to file bankruptcy and/or lose the house, if you ask me, but that’s a decision that’s easier to make in theory than in practice.)
Well, your very own cite that shows the Federal tax rates peaked at 92%:eek: in 1953, and were as high as 50% as late as 1986, went to 39.6% in 2000 and are only 35% now. Last time they were that low was 1931, when no one on this board was paying income taxes.
Well, and that if you tap into your IRA you run the very real risk of losing both your retirement* and* your house.
I’m not talking about the management approach of the funds, I’m talking about the expense ratios. Even with an inexpensive fund like Vanguard Index 500, the investor shares have an expense ratio of 0.18%. The admiral share class in this same fund has an expense ratio of 0.07%. Most people aren’t going to be able to meet the minimum investment in order to get the admiral shares in their IRA.
All (or almost all) fund companies work this way. They have lower expense ratio funds for large institutional investors. If you’re in a large enough plan, like your employer’s 401(k), you can get into these share classes. Individual investors opening their own IRAs are typically going be buying into the higher expense ratio fund classes.
I am talking abut the same thing. Actively-managed funds have higher expense ratios - to pay for the management that usually has the effect of producing lower returns than indexing (or, indeed, than throwing darts at the WSJ stock page).
The difference between admiral and investor shares in your example is just 0.11% Actually, you would have been better off comparing investor shares with the Vanguard Institutional Investor fund with an ER of 0.02%, giving a difference of 0.18%
The difference in ERs between different classes of the same fund is dwarfed by the difference between actively managed funds and index funds, and between low-cost providers and insurance companies that provide the bulk of 401(k)s.
Being in a 401(k) means you can have access to funds without having to pay the front-end load (class A) or back-end (class B) (which should be an irrelevant benefit as there are plenty of funds to choose from without paying loads). Looking at American funds (the first one I thought of - and American funds are highly regarded), a 401(k) may be able to get Class C shares (minimum investment $500,000) and avoid the load, but then you pay even higher annual ERs. Class Cshares typically have ERs of about 1.5% versus about 0.8% for the class A and B. Hence these fees are way higher than the investor shares at places like Vanguard.
American does offer class F-1 shares with lower ERs, but these are not available through 401(k)s - they are only available if purchased through an advisor to whom you are paying an additional asset-based fee.
If you disagree, find me actively managed funds where the ER when provided through 401(k)s is below the 0.18% of the Vanguard S&P 500 investor fund, and that you cannot get for yourself in an IRA. Even if you can find any, which I doubt, that will only be of benefit to you if your particular 401(k) offers these funds. That has never been the situation in any 401(k) that I or my wife has held. Share with me what ERs are in your 401(k), if you have one, and I will share with you the ERs I am paying outside my 401(k).
Google “401k fees” and find me articles extolling the benefits of the lower fees you will pay through having access to institutional funds or share classes. But be honest about how many pages of articles on high 401(k) fees you had to wade through first.
Yes, that’s true, but I don’t think it invalidates my point. Taxes do tend to increase over time, although there is significant noise in the signal.
I could say “The stock market tends to increase over time”, and you could point to periods (even quite long ones) in which it did not, but the general trend still exists. Furthermore, it’s generally believed that investing in the stock market with a long time horizon is a good plan, even though you may lose money for a decade or more. By the same logic, it’s a good idea to pay your taxes when you’re young, because on average, the rates are going to be higher in the future. It’s not a sure-fire absolute 100% certainty that taxes will increase, but they seem to do so, in general.
Your analysis is flawed because you’re not counting the taxes that you already paid before putting the money into the Roth IRA. You have to pay income taxes on the Roth just as you have to pay income taxes on the 401k. The only difference is that you have to pay an additional 10% penalty on the 401k, and whatever the different marginal tax rates are.
DrDeth’s argument was that people who take money out of their 401k are at a lower tax bracket. My point was to show that taking money out of your 401k puts you right back up into the higher tax bracket because it is taxable income.
It was not meant as a comparison of total taxes paid over time, simply in the year of distress when distributions are made. I offered the Roth comparison because that really does preserve the lower tax bracket.
That said, the Roth/401k comparison isn’t just a simple comparison of the penalty and the difference in marginal rates. You have to look at the cost of the initial contributions (pre-tax vs post-tax money has different value) and include the fact that growth on the Roth contributions is also tax free.
Well - that could be. But for the last 60 years, all that noise in the signal has masked a general decrease in overall tax rates. That’s a big part of why, in 2009, Americans had their lowest tax burden of any year going back to 1950. And you can thank both Clinton and Bush for changes in the tax code which had a big part in this.
This link has some nice charts showing the average tax burden, by year.
Well, it puts you higher, but it’s still not likely to put you as high as you used to be.
The hypothetical person who needs $100k for expenses and needs to withdraw $40k from the retirement account must have been making significantly more than $100k previously in order to pay taxes on his income and put money away for retirement. In that case, withdrawing from the 401k is more likely to be income smoothing, which will reduce average tax burden (that’s probably one of the reasons there’s a penalty for early withdrawals).
Kiber, that’s a great chart.
With a traditional IRA you pay taxes on your investment and your earnings at the time of withdrawl at the rate when you withdraw.
With a Roth, you pay taxes on your investment when you make it but you pay no taxes on the earnings.
Of course there is no guarantee that you’ll have earnings but if you don’t have a reasonable expectation of earnings, why are you investing at all? Put your money under the mattress in that case.
Also, for some people, their income and employer provided pension doesn’t allow them to skip the taxes on the investment when made. For those people the traditional IRA is a really bad idea.
Unless there is a recent change, there is a loophole that won’t let me contribute to a Roth IRA, I can’t deduct my traditional IRA contributions but I can put money in a traditional IRA and immediately convert it to a Roth.
Bottom line, never take investment advice from someone who makes blanket statements.
Except that if you REALLY FUCKING NEED the money, you are quite likely in a lower tax bracket, eh?
Yes, but now you are assuming that your earnings will be greater than your contributions. Of course there will be earnings, but how much and when? In general, the bad thing about a Roth IRA is not the tax differnce but the fact that it’s easier to take money out. It makes it too damn easy, thus dudes who can’t afford to take the money out will anyway, which is bad. For the filthy rich, a Roth is better.
And yes, there are circumstances where you can’t get a conventional tax free contribution to a IRA, but then we are comparing apples to oranges.