smellthejeta said:
So... What I've concluded is this: How much to save and what to do with it are dependent on your savings goals, age, and how close to retirement you are. I'm young; I'm saving for short term (moving, house purchase) and long term (retirement). I'm in a fairly low tax bracket now, compared to where I will be when I'm closer to retirement. Somebody closer to retirement has different goals than I do, and therefore they should invest/manage their money differently.
I agree 100%. Also, someone who is 25 has a different risk level than someone who is 55.
smellthejeta said:
Let's start with me and where I'm at. Conventional wisdom states that I should fund my 401(k) to my company max and no more. Why? The company match is free money, and is essentially a 100% ROI. Guaranteed. Nothing can beat that.
I agree to a point...but there is no such thing as "conventional wisdom" here. I have read many personal finance books and for many of these big issues, there always seems to be good arguments made for both sides of the issue. Another big issue is whether or not to prepay extra mortgage payments versus holding the biggest longest mortgage possible and only make the minimum payments. But I do agree that at the very least, employees should be contributing the minimum to receive the maximum amount of matched company money.
smellthejeta said:
But here's the catch: Since my contribution is before taxes, I am opting NOT to pay taxes while I'm in the 17% bracket (or whatever it is I'm at). However, my withdrawls (or capital gains or whatever) will be taxed -- when I am more likely to be making more money and thus in a higher tax bracket. IOW, I am opting to NOT pay income taxes while I'm in the 17% bracket in exchange for paying taxes on a lot more money while I'm in the 50% bracket.
For starters, there is no 50% bracket that I am aware of, but I could be wrong. Secondly, you and I have no clue what the tax rates will be 20-30 years from now.
smellthejeta said:
The company match and compounding and hopeful growth will make up for the higher tax rate. However, anything put into a 401(k) beyond the company match is questionable, because I will be paying more taxes on it later at the expense of less taxes on it now.
I disagree. You leave it out the fact that by contributing more of your own money pre-tax, you are saving on taxes today. If you invest those savings, they will compound over the long term. Don't ignore the compounding of money over time. That invested savings may very well beat out the tax savings that you are talking about downstream. Of course, in order to model this correctly, we'd have to make certain assumptions about the tax rate downstream, income growth, contribution rates, inflation, rate of return on your investment, etc. It is obviously a very complicated investment model when you get down to the facts.
smellthejeta said:
So, let's look at the Roth IRA. My contributions are after taxes -- that means that I'm paying taxes on my contribution NOW, while I'm in the 17% bracket. Later on, when I'm in the 50% bracket, I pay nothing on my withdrawls.
Again, you have no clue what the tax rate will be 30 years from now nor do I know of any 50% tax bracket. You also have no clue what kind of adjusted income you will have 30 years from now - in other words, you have no clue what your taxable earnings will be nor do you know what your effective tax rate would be.
smellthejeta said:
For more on the tax thing... Money you put into the 401(k) and the Roth CAN be taken out early for emergencies, but there's a catch. Under most circumstances, early 401(k) withdrawls will hit you (or expose you) to a lot of tax consequences, such as income taxes and early withdrawl penalties. The principal of the Roth can be withdrawn at any time with no tax consequence.
Of course. I'm well aware of these facts. I'm also aware that you can take a loan from your 401k and when you pay interest on that loan, it goes to you...not some bank. That said, there are some very serious implications of taking a 401k loan that anyone should consider.
smellthejeta said:
Also, in regard to taxes: You talk about the tax break, but what are you trying to gain? For me (and most regional pilots in their early years), I get a deduction on student loan interest, a credit for going to school, and my medical benefits are pretax contributions. I'm not doing poorly at tax time, and in fact, usually get a fat check. Again, I'm in a lower tax bracket, so I just don't pay that much in taxes. Essentially, for every dollar I owe income taxes on now, I pay $0.17 in taxes. Later on, every dollar I owe taxes on I will pay $0.50 in taxes. It doesn't make sense to me to save that seventeen cents to pay fifty cents on it later. I'd rather pay the seventeen cents now than pay fifty cents later.
As I said above, don't ignore the opportunity cost and power of compounded money over time. The goal is obviously to pay zero taxes...and contributing as much to your 401k (get as close to 14,000 this year as possible) will lower your taxable income by that amount. In the perfect world, one can afford to max out both the 401k as well as the ROTH IRA. Also don't forget that your earnings level will grow after year 1 at a regional and also, there are income limits on the ROTH.
The bottomline is that there is no blanket solution or right answer here. It is all subject to a bunch of variables and it would be incredibly difficult to model out the correct decision without a very good CFA. There are pro's and con's to both arguments.
-Neal
. I agree!
