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Old 04-28-2006, 11:42 AM
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DeepPurple DeepPurple is offline
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Default Wisdom of 401k Contribution Maximization

I am not a financial newbie, but I recognize that there are people here who have even better financial backgrounds than my own.

I can see contributing to the point of maximizing your employer's match. Beyond that is a different story. I could be paying a 25% marginal federal tax on those dollars now. What if my marginal rate is 50% when I retire? Will the tax deferral of earnings for the next 30 years overcome a drastically more progressive tax structure (DMPTS)? A DMPTS that will be necessitated by the trainwreck that is social security.
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Old 04-28-2006, 11:46 AM
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You'll be defering that tax until you retire (45-0 years). You can figure out the time value of that deferral. I contribute 14K to my 401k but I also contribute about 2K to my Roth for tax diversification.
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Old 04-28-2006, 11:54 AM
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Quote:
Originally Posted by Jack
You can figure out the time value of that deferral.


In order to make this calculation, I need to make assumptions about 1) when I'll retire 2) rate of return over the next 25 years both nominal and real 3) tax structure I'll face in when I retire 4) portion of total rate of return I can defer via capital gains on post tax investments


number 3 concerns me the most.
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Old 05-01-2006, 03:12 PM
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Quote:
Originally Posted by DeepPurple
In order to make this calculation, I need to make assumptions about 1) when I'll retire 2) rate of return over the next 25 years both nominal and real 3) tax structure I'll face in when I retire 4) portion of total rate of return I can defer via capital gains on post tax investments


number 3 concerns me the most.
So, you're really worried that they'll tax the hell out of everyone's 401(k) distributions to save Social Security? You don't think it will occur to anyone that that doesn't make a tremendous amount of sense?
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Old 05-01-2006, 04:33 PM
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Quote:
Originally Posted by Emily
So, you're really worried that they'll tax the hell out of everyone's 401(k) distributions to save Social Security? You don't think it will occur to anyone that that doesn't make a tremendous amount of sense?
Since when does any government financial program have to make sense?
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Old 05-01-2006, 04:58 PM
Steve Grondin Steve Grondin is offline
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Quote:
Originally Posted by Emily
So, you're really worried that they'll tax the hell out of everyone's 401(k) distributions to save Social Security? You don't think it will occur to anyone that that doesn't make a tremendous amount of sense?
It isn't so much that they will be taxing the heck out of just 401(k) distributions to save SocSec. They will tax all income, 401(k) distributuions just happen to be one flavor, to spend it. SocSec won't always be the cash cow for the feds it currently is. We expect too much from the govt and are paying too little. Tax rates will go up.

I think the main risk to be evaluated is the tax structure. Outside of tax sheltered accounts, even individual stocks can force timing of recognizing gain, through dividends or sale of company/spinoffs etc. I think the best way to do it is to do some multi-scenario analysis.

Some 401(k) plans allow you to roll out ee contributions to a personal IRA without losing right to er match. If yours has high fees see if this option is available.

Based on this and other threads, I think I'm gonna rename DeepPurple DeepPockets

Remember, DP, that the child tax credit starts phasing out at $110K MFJ AGI. This is an extra 5% marginal rate on fed. Course, median FCAS might be beyond phaseout even at max 401(k)/cafeteria plan deferrals, but for the rest of us making less, it is something to remember.
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Old 05-01-2006, 06:30 PM
Westley Westley is offline
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Quote:
Originally Posted by Emily
So, you're really worried that they'll tax the hell out of everyone's 401(k) distributions to save Social Security? You don't think it will occur to anyone that that doesn't make a tremendous amount of sense?
It'll make a lot of sense to somebody who doesn't have anything in their own 401k, and their only chance to retire is to ensure the solvency of SS. So, it depends on the relative strength of the voting bocks.
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Old 05-13-2006, 12:54 PM
Samuel Samuel is offline
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I think this is a very good thread.

A couple of things to add: most of us will not be earning "0" in retirement: even if we don't have a part time job or pension, we will (hopefully) be collecting social security. So your 401k distributions will probably not be exempted in whole or in part by the standard deduction, and may not be confined to the lowest tax bracket. In my case, I'd guess that the tax rate of a 401k distribution will be approximately the capital gains rate, and probably a little higher. Since I tend to put my money into relatively tax efficient indexed mutual funds, the tax advantages of a 401k are seriously reduced for me. I do have more ability to reallocate my 401k assets than I would if I simply bought and held a group of stocks, but I have less ability to use my 401k assets to meet emergency life expenses that may come up.

In defense of the 401k, you can roll it into a traditional IRA when you switch employers. A traditional IRA has the advantage over a Roth IRA that you can roll it into a Roth IRA whenever your income drops. There is an option value embedded: you can pay your taxes when you think that you are in the lowest tax bracket you ever think you will be in: in retirement or otherwise.
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Old 04-28-2006, 12:43 PM
Buck Fama Buck Fama is offline
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Quote:
Originally Posted by DeepPurple
I am not a financial newbie, but I recognize that there are people here who have even better financial backgrounds than my own.

I can see contributing to the point of maximizing your employer's match. Beyond that is a different story. I could be paying a 25% marginal federal tax on those dollars now. What if my marginal rate is 50% when I retire? Will the tax deferral of earnings for the next 30 years overcome a drastically more progressive tax structure (DMPTS)? A DMPTS that will be necessitated by the trainwreck that is social security.
You ask a very good question...I've been thinking of dropping my contribution a bit for a couple of reasons:

1) I'm also not convinced that tax rates will necessarily be lower when I retire...in fact I feel like they'll go up
2) Money in a 401K is taxed at ordinary income tax rates when you withdraw it, no matter whether it is invested in stocks or bonds...so if you took some of the money in your 401K that you allocate to stocks, and instead invest it in a taxable account, you'll likely be paying tax at the long term capital gains rate when you withdraw it...so unless you think that there will be no differential between ordinary income tax rates and capital gains tax rates in the future, the tax deferral of the 401K loses some of its luster
3) Expenses in funds in a 401K tend to be higher than those in a mutual fund...in my 401K, the S&P 500 Index Fund has an expense load of 30 bps, and the bond index fund has an expense load of 50 bps...at Vanguard I pay expense loads of 9 bps and 11 bps, respectively, for the S&P 500 Index Fund and the total bond market index fund

So I would say that it's very clear that you should invest enough in a 401K to get the maximum employer match...beyond that, I am not certain that you might not be better off investing outside the 401K, particularly for money going into equities
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Old 04-28-2006, 01:05 PM
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Dollars contributed today reduce your top marginal rate. Dollars pulled out in retirement will come out at your then effective tax rate which after even the standard deduction is often considerably lower than your marginal rate. Something to at least consider.

There is a good article on this where they weigh the pros and cons of Roth-401(k) v. trdaitional 401(k) in CCH's Journal of Pension Benefits (subscription required).
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