My daughter's employer, probably because it does not overpay staff (to put it politely), offers a whopping 401k match, I dunno exactly, something like up to 25% or 50%.
Fully vested, she currently contributes 7% but is thinking of going up to 10%, conceivably higher. Been listening to Orman
.
That would straiten her cashflow somewhat, obvs.
I additionally fund her Roth out of some small inheritance moneys, not endless, so she is not badly positioned for a 28yo.
Question for calculator types: Would it be smarter *not* to fund her Roth, or to fund it less, and give her the delta so she could up her company-matched 401k amount?
I know this is complex future math (I assume the same return rate going forward), and I am inclined to continue things as they are, but she sure hates turning down any free moneys from the employer, as do I.
Maybe there is no clear answer. But I thought I would pose to the smart people here, esp those CFP types who run these sorts of scenarios. Thanks much for any thoughts.
Comments
Here what I think it might look like:
Reason: A number of years ago a friends' wife had the same type of situation. Her hubby told her to fund it to the max. ( they had the means to do this) It wasn't long & the employer cut the contribution back to 4 or 5 %.
Good investing, Derf
Hmm, must reread and digest, and then again. @Tb, thanks for compliment; we are a lucky family to be able to afford even this much, for however long it goes and whatever the proportions are.
Not sure she is going to like the idea of being 'supported' via Roth rechanneling so she can cock her salary toward 401k bigtime. I can explain.
@derf, interesting story. Not sure why this family-owned business does it this way.
That's because, if you were to take out $1.33 from a traditional account now, you'd owe 25% in taxes, and would be left with $1. Same after tax value as if you took $1 out of a Roth now.
If the account were to double over time, you'd have $2.66 (pre-tax), and after 25% in taxes, you're be left with $2. The same $2 that you'd have if you'd put $1 in a Roth and it doubled.
Now you have all you need to compare the two choices, remembering that $1.33 in the 401k is worth about $1 in the Roth.
Put $1 in the 401K, and the employer will put in somewhere around 33c. That is, the value will be about the same as putting the $1 into the Roth.
But the kicker is that your daughter also gets to declare $1 less in income on her income tax return (worth around 25c). And, she gets to pay less in payroll taxes. No question - the 401k with big match wins.
As reward I insist you fix yourself a drink and go take the pleasure of reading Hiltzik tonight (random excellence in pol analysis: http://www.latimes.com/business/hiltzik/la-fi-mh-sen-schumer-20141126-column.html.)
This reminds me of the "good old days" of FundAlarm, where responders would helpfully give their advice and well thought out opinions on some fairly complex questions. I certainly have benefited from the advice and suggestions of MFO contributors, and it's a real pleasure to see that spirit is still with us. Thanks for your contributions, and that also goes for anyone else trying to help.
davidrmoran
December 2 Flag
I was sooo hoping analytical you would chime in. tyvm tyvm.
As reward I insist you fix yourself a drink and go take the pleasure of reading Hiltzik tonight (random excellence in pol analysis: http://www.latimes.com/business/hiltzik/la-fi-mh-sen-schumer-20141126-column.html.)
Hi Jacker !? What in the sand hill does this have to do with 401-k or roth ?
good investing , Derf
The company match for my daughter is 25%. Her 2015 limit is 18k, over a quarter of her salary. Gah, we must crunch the numbers to see what to do concretely. The selling point ('the appeal' would be the better term) will be not just the >4k free money from employer but the cashflow increase from reduced taxes.
msf always deserves a tip of the hat ... really appreciate it whenever he chimes in.
I'm late to the party here. Agree with the other's that it's pretty much a no-brainer for all the reasons given. I think the old BF proverb about "a bird in the hand ..." may well apply. Remember that the advantages of a Roth don't come for free. You pay a price by sacrificing funds that could otherwise be invested and compounding for what amounts to an early tax payment.
There are however some arguments for the Roth option. (1) As I think you allude to, that option could be phased-out at some future time. So, getting into one while they are still available is a compelling thought. (2) A nice feature of the Roth is the ability to withdraw your original investment (but not the gains) at any time without penalty. For youngsters considering a first home purchase that may have some appeal. (3) the Roth option allows wider freedom of investment options and doesn't limit one to the employer-selected custodian. (4) There may be a psychological factor at play here. The people I know with employer matches seem to "abuse" their accounts more by taking out loans against those assets. To them it's a big piggy-bank. On the other hand, someone who "coughed-up" every dime in the account may view the $$ a little more seriously.
All said ... still agree with the 401K option. Apologies if I repeated some of what has already been said.
You noted: "Remember that the advantages of a Roth don't come for free. You pay a price by sacrificing funds that could otherwise be invested and compounding for what amounts to an early tax payment."
I don't follow this part in particular.....by sacrificing funds that could otherwise be invested and compounding
I've been outside most of the morning and the wind chill is about 15. Perhaps I'm just too cold.
Thanks,
Catch
Example 1: Jane Doe decides to utilize $10,000 of her annual income for retirement investing. If she elects to fund a Traditional IRA or 401K with that portion of her income, she pays no taxes up-front on the money. The entire $10,000 is immediately invested in the mutual fund(s) of her choice and begins growing and compounding for her.
Example 2: Jane decides instead to fund a Roth IRA. Let's assume her combined state and federal income taxes amount to 20%. After paying taxes up-front on that $10,000 income, Jane now has $8,000 left to invest.
At the onset, Jane has an extra $2,000 working for her. Since she will eventually "pay the piper" by paying taxes when she withdraws the funds, the Roth option may still be more desirable. Just trying to present the other side of the coin here.
Okay, now I get the drift of the statement. Yes, we've done all of this at this house, with the Trad. IRA (before the birth of Roth); as well as the 401k's and Roth's.
Thanks,
Catch
After some period of time, say the investment doubles. Apples-to-apples, same investment whether in the Roth or a tax-deferred plan (traditional 401K or IRA). The 401k now has $20K in it. Assuming tax rates didn't change, Jane can take out the $20K, pay $4K (20%) in taxes, and be left with $16K. Meanwhile, that $8K in the Roth has doubled to $16K, which is what Jane gets when she takes the money out (no taxes due).
Where things can change: the tax bracket in the future may be different. Higher and the Roth wins; lower and the traditional plan wins.
What can also be different is what is limiting the contribution amount. You made the assumption that the limiting factor was cash on hand (here, $10K). If the limiting factor is the legal limit, well, contribute to both the 401k and an IRA.
(But if we're talking about having enough cash to contribute the legal limit to a traditional IRA or Roth IRA, the Roth wins. That's assuming all else, especially tax rates over time, are equal. I just wanted to point out that there are other factors; I'll explain more some other time.)
(I do realize that these are what is called 'rich people's problems'.)
msf: I'm surprised at that and will continue to look for some flaw in this argument - if there is one. For now, your analysis appears correct (suspiciously so
One consideration you overlooked is that younger investors tend to invest more aggressively. So, having more money "on the table" early on might tilt the equation in favor of the Traditional IRA.
We might agree that, on-paper anyway, Jane's assets look considerably larger for purposes of establishing credit-worthiness during a mortgage-app, etc. (tax considerations aside).
Yes - My analogy was based on how much an average working person might be able to free-up from income for investment purposes without outside help. Reflects my decidedly pedestrian roots.
She might qualify for things that she would not have otherwise qualified for at a higher income. One that comes to mind is a tax credit for low income earners who contribute to their Roth or 401K (I believe it is called the Saver's Credit).
"The saver’s credit helps offset part of the first $2,000 workers voluntarily contribute to IRAs and to 401(k) plans and similar workplace retirement programs. Also known as the retirement savings contributions credit, the saver’s credit is available in addition to any other tax savings that apply."
link:
Tax-Credit-Helps-Low-and-Moderate-Income-Workers-Save-for-Retirement
Also, if your daughter has student loans many are income based. If she is trying to qualify for program "xyz" (you fill in the blank) many of these programs are income based.
As a personal note: my starting salary as a teacher (with a Master degree) was so low that I qualified for a first home buyers program. I sadly also qualified for welfare and this is still the case with adjunct professor at many of the institutions of higher learning where kids go to get a good "debt-ucation".
Bottom line...if your daughter can save and learn to live on less you will be able to move in with her when you're older and she's richer.
If your daughter has a HSA (Health Savings Account) she can make a one time contribution to her HSA by moving money from her 401K to her HSA account (considered a one time rollover). This, in a sense, allows tax deferred dollars (401K) to be rollover into a tax free account (HSA).
This can only be done once in a person lifetime. Good to know if you have an HSA.
Article:
kiplinger.com/article/irules-for-ira-to-hsa-rollovers
Work Sheet:
https://hsaresources.com/pdf/IRA_to_HSA_Worksheet.pdf
Yep - Thanks
I suspect the pin-hole, if there is one, arises from the fact that we grow progressively more conservative in investing over time. So, two investors, following the different scenarios I outlined for Jane, will not grow their money by the same multiplier over the longer term.
The additional (dollar) gains from having more money invested initially, at the more aggressive stage, should put the Traditional IRA out in front where it should remain.
I "suspect" this, anyway
No loans of any sort, thank God.
I will investigate HSA.
She will likely get our current house someday and no one will have to move in with anyone else. I am just glad she has a steady job with a future, given a BA in art history; frugal habits; and lowish rent (for Boston).
My starting teacher salary here 45y ago, with a master's, was $5600 (lower-tier prep school). I sympathize.