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 Post subject: Priority for retirement accounts
PostPosted: Fri Nov 16, 2012 5:04 pm 

Joined: Tue Jun 12, 2012 4:34 pm
Posts: 470
I've run across several articles, blogs and forum posts that advise the following priority for retirement accounts:

1) 401k up to company match
2) Roth IRA up to max
3) 401k remaining up to max
4) taxable accounts

I'm wondering why this seems to be the most common advice given. Is it for the tax-deferred growth advantages of the Roth?

I currently contribute 10% to my TSP (like 401k), and receive a 5% match. I'm planning my financial goals for next year, and was intending to increase my contribution by the amount of my upcoming raise (3%), but was wondering if I should look into the IRA instead. My TSP has extremely low fees (0.025%), so I'm kind of thinking the conventional advice shouldn't apply in my situation. (FWIW, my original longer-term plan was to keep adding my raises to my TSP until I hit the limit and then open an IRA.)


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 Post subject: Re: Priority for retirement accounts
PostPosted: Fri Nov 16, 2012 6:38 pm 

Joined: Mon Nov 01, 2010 5:15 pm
Posts: 1119
If I were you, I'd probably go the Roth route before the 401K since the tax rate ain't going down in the future.


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 Post subject: Re: Priority for retirement accounts
PostPosted: Fri Nov 16, 2012 9:25 pm 

Joined: Tue Jun 30, 2009 9:44 pm
Posts: 273
Location: Atlanta, Georgia
Building on the original questions, why do those articles/blogs/forums never seem to distinguish between traditional 401(k)s and roth 401(k)s? How does the option of a roth 401(k) change the advice?


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 Post subject: Re: Priority for retirement accounts
PostPosted: Sat Nov 17, 2012 11:23 am 
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Joined: Sun Aug 10, 2008 2:50 pm
Posts: 154
Location: South Florida
I believe that Roth 401k's are still just not that common overall ... so they are hardly mentioned. My company actually offers both a traditional 401k and a Roth 401k. There is an index fund in my company's Roth 401k that has an extremely low expense ratio ... lower than anything that would ever be available to me personally in my Roth IRA. So I am familiar with the situation that you're describing.

I've always contributed in the Roth 401k up to the full company match just because it's free money and I'm entitled to it as part of my compensation package ... so that's a given and that's why it's always mentioned as top priority in the list.

Now the question is whether to do Roth IRA or Roth 401k next, assuming that you can't max out both (which would be ideal) and have to make a choice. Because the Roth IRA contribution limit is fairly low, my answer would depend on whether you can max that out or not ... if you can max out the Roth IRA, then I would do so and then put whatever else you can into the Roth 401k ... otherwise perhaps split evenly. The reason that I have a personal preference for the Roth IRA over the Roth 401k is because you own it. It is not controlled by your employer. You can switch investment companies ... you can switch funds. If your employer makes a change to the structure of the Roth 401k, you have no recourse ... you can only choose among the limited selection of funds that they've made available to you in the one investment company that they offer.

For example, until recently my work had two index funds with extremely low expense ratios as part of their offerings. About a month ago I got the announcement that they were switching one of them to some other fund with a standard (much higher) expense ratio. That caused me to move my entire balance into just one fund. Now, if they ever switch out that final fund to something else that I don't like, I'm royally screwed because I have to keep my money in there but there wouldn't be any other options that I would like. Contrast that with the Roth IRA where I can make unlimited changes at will ... because it's 100% mine.

Just my two cents.


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 Post subject: Re: Priority for retirement accounts
PostPosted: Sat Nov 17, 2012 11:56 am 

Joined: Tue Jun 30, 2009 9:44 pm
Posts: 273
Location: Atlanta, Georgia
Thanks for your insight, frugalcoconut. That's very helpful. Unfortunately, I do not have the option of contributing to a Roth IRA. My employer offers both traditional and Roth 401(k)s, with the same fund offerings for both. As I understand the 401(k) contribution rules, the employee can only contribute a total of $17,000 for 2012, whether that's all to traditional, all to Roth, or split between them. (This is going up to $17,500 for 2013.) I currently do a 50/50 split and have contributions taken out of my salary evenly through the entire year. I've been considering shifting more towards one or the other, but I guess I sit at the even split because I just don't know how I want to plan my distant future (not yet married, kids, etc.) and it seems like a safe compromise.


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 Post subject: Re: Priority for retirement accounts
PostPosted: Sat Nov 17, 2012 12:24 pm 

Joined: Mon Feb 04, 2008 7:35 am
Posts: 1148
Location: Maryland
Similarly to how they say you should diversify your funds, you should also diversify your taxable/tax advantaged monies.

You know your current tax rate, so while you have the chance, use your after tax money for your Roth, and max it out (you'll only pay taxes on your earnings). Then, when you retire, you will only have to pay taxes on the money in your 401k. Because the limits are so varied (17,000 vs 5,000), of course, most of your money will be taxed at the higher rate, but having money to spend tax free will be great once that day comes.

My thinking is that somehow I will be at a lower tax rate for my 401k once I retire, but who knows? That's the question of the million dollars-how do I get a low tax rate with a ton of money in the bank. HA!!HA!!


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 Post subject: Re: Priority for retirement accounts
PostPosted: Sat Nov 17, 2012 1:01 pm 

Joined: Tue Jun 12, 2012 4:34 pm
Posts: 470
Thanks, Peachy. It makes sense when you put it that way.

I know tax rates are the lowest they've ever been, and will not stay this way for long. I still think, though, for my personal situation, the conventional wisdom isn't the best to follow. I'm looking for someone to point out any holes in my logic so I can be sure I'm seeing all angles as I make my decision.

Right now I am the sole breadwinner in my family, living in an extremely expensive area. The hubby is a student, and has about 2 to 2.5 years left of school. I personally think the most important thing right now for us is to minimize our tax burden and maximize our cash flow in order to keep our savings high during our one-income period. By the time he graduates, I should be at or near the yearly cap for my TSP contributions, and the intent was to start Roth IRAs for the both of us when he graduates and is working. That still gives us 20 to 25 years of Roth contributions that will help us diversify our tax requirements in retirement.

I realize I'm taking a risk with taxes in retirement. We don't know what taxes will be, but it's pretty much a guarantee they will be higher than they are now. Is there anything else I'm not seeing?


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 Post subject: Re: Priority for retirement accounts
PostPosted: Sat Nov 17, 2012 6:06 pm 

Joined: Wed Oct 17, 2012 7:38 pm
Posts: 5
alohabear wrote:
I've run across several articles, blogs and forum posts that advise the following priority for retirement accounts:

1) 401k up to company match
2) Roth IRA up to max
3) 401k remaining up to max
4) taxable accounts

I'm wondering why this seems to be the most common advice given. Is it for the tax-deferred growth advantages of the Roth?



Perhaps because financial advisers don't get paid for your 401k contributions? 8)


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 Post subject: Re: Priority for retirement accounts
PostPosted: Sat Nov 17, 2012 6:56 pm 

Joined: Sun May 29, 2011 4:50 am
Posts: 168
alohabear wrote:
I still think, though, for my personal situation, the conventional wisdom isn't the best to follow. I'm looking for someone to point out any holes in my logic so I can be sure I'm seeing all angles as I make my decision.


I'm far from an expert, but as I understand it, the recommendation is to take advantage of what tax-advantaged account (401k, roth 401k, roth ira, traditional ira) that you have available.

Whether you do the traditional 401k or roth 401k has to do with whether you think you'll be in a higher tax rate now or later, but regardless of what you think you'll be in, having your money in taxable accounts is the least favorable choice.

Now as far as 401k up to the company match, the logic is that you don't want to leave free money on the table.

Then roth ira (5k) because of flexibility of investment choices.

Then the rest of the 401k (up to the legal limit of 17k this year) to max out your tax advantage account. If you're able to do this, you're putting away 22k a year toward retirement) that is tax advantaged.


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 Post subject: Re: Priority for retirement accounts
PostPosted: Sun Nov 18, 2012 7:57 am 
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Joined: Wed Sep 23, 2009 9:01 am
Posts: 5285
silvor wrote:
alohabear wrote:
I've run across several articles, blogs and forum posts that advise the following priority for retirement accounts:

1) 401k up to company match
2) Roth IRA up to max
3) 401k remaining up to max
4) taxable accounts

I'm wondering why this seems to be the most common advice given. Is it for the tax-deferred growth advantages of the Roth?



Perhaps because financial advisers don't get paid for your 401k contributions? 8)


Perhaps. But most people don't pay them for any of those. They might make money from fees on mutual funds but those would often be the same in 401(k)s.


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 Post subject: Re: Priority for retirement accounts
PostPosted: Sun Nov 18, 2012 8:10 am 
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Joined: Wed Sep 23, 2009 9:01 am
Posts: 5285
I bristle at the "traditional" advice. It's probably fine for most people who plan for a typical life and expect steady taxes. But in our personal situation it doesn't make much sense.

1. We will be retiring early, in our early/mid 50s so we will need to draw money out earlier than the 59-1/2 limit.

2. We expect taxes to be going up a lot. I think Congress will find a way to tax withdrawals heavier. It will be a backdoor, not so obvious approach perhaps by making them subject to Social Security taxes or by offsetting Social Security payments against them.

3. Right now, even under current tax rates, we will get hammered by taxes once required minimum distributions hit. We'll be forced to take income we do not need and pay taxes on it.

There are ways of dealing with these issues. But take it from someone who is close to the reality of withdrawal - tax-deferral is not all it's cracked up to be.

In our case we have always invested quite a bit in taxable accounts. Those withdrawals are free of hassle. You can also control taxes better on a yearly basis. If you stick with index funds and don't trade much you also effectively get the same tax deferral as a 401(k) or IRA without a bunch of rules.

But each person should do the analysis themselves and pay very close attention to the assumptions. In most cases the 401(k)/IRA route will be very attractive. Just be careful what you assumes about future taxes and don't ignore RMDs.


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 Post subject: Re: Priority for retirement accounts
PostPosted: Mon Nov 19, 2012 12:32 pm 

Joined: Tue Jun 12, 2012 4:34 pm
Posts: 470
Thanks DH, and the rest, for your responses. They've helped remind me that, while the generic advice is often good for many, it is (after all) generic advice. I think that it's really easy for people to get caught up in "the right way" of doing things - especially on financial forums. It helps me to remember that every situation is different, and even the traditional advice does not always apply.


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 Post subject: Re: Priority for retirement accounts
PostPosted: Wed Nov 28, 2012 3:29 pm 

Joined: Fri Sep 12, 2008 12:29 pm
Posts: 1592
Location: Seattle, WA
Justus wrote:
I'm far from an expert, but as I understand it, the recommendation is to take advantage of what tax-advantaged account (401k, roth 401k, roth ira, traditional ira) that you have available.

Whether you do the traditional 401k or roth 401k has to do with whether you think you'll be in a higher tax rate now or later, but regardless of what you think you'll be in, having your money in taxable accounts is the least favorable choice.

Now as far as 401k up to the company match, the logic is that you don't want to leave free money on the table.

Then roth ira (5k) because of flexibility of investment choices.

Then the rest of the 401k (up to the legal limit of 17k this year) to max out your tax advantage account. If you're able to do this, you're putting away 22k a year toward retirement) that is tax advantaged.


I agree pretty much with Justus's explanation.

I would add to the "then roth ira" paragraph: the personal finance blogosphere has a(n arguably irrational) love for the Roth IRA. That's why it's second only to the theoretically instant 50-100% gain of an employer match.

Control and flexibility are nice, too. And most people who are considering maxing anything, and have a 401(k), are probably ineligible to contribute to a deferred traditional IRA. (A non-deferred TIRA is probably an option, but not a very good option.)

I would personally recommend a method that takes tax diversification into account, but then it wouldn't be a simple list as in the OP. The primary benefit of one size fits all rules of thumb is that they are simple to understand and implement.


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