Non-tax advantaged investing over 401k situation

Question

Is it worth bypassing a 401k in favor of a normal taxable investing account if you can contribute while in the 15% tax bracket and plan to retire in that bracket as well?

After crunching some numbers, it really doesn't matter if you pay the taxes now or later with a 401k unless you are going into a lower bracket.

My assumptions (or things to do before attempting this)

• Contributed to a 401k to bring down taxable income to 15% if not there already
• Have already maxed out a Roth
• Highly likely to retire into this bracket (which seems very reasonable without a mortgage)

Another possible quirk with this is that it also depends on capital gains being 0% when withdrawing in the 15% bracket. This is what I believe the law currently is, please correct me if I am wrong.

If I am looking at this properly it looks like a very good opportunity to have easier access to your money as well as cheaper investing options.

Are there any flaws in how I am looking at this?

Answer 1

There are a couple of cases where I'd argue in favor of the 401k:

1. Employer matching - If the employer matches your contributions, then it makes sense to get these additional investments which if you are in a low bracket may exist as highly-compensated employees may want those in the lower brackets to contribute as much as they can.

2. Investment options - If the employer has enough assets in the plan, there could be access to institutional versions of those funds. For example, compare Vanguard Institutional Index Instl Pl (VIIIX) with Vanguard 500 Index Inv (VFINX), where the expense ratio in the former is just .02% while the latter is .17%. Granted this is a minor difference in expenses, there is something to be said for how much a .15% drag year over year could add up.

Answer 2

With no match, the traditional 401(k) for someone otherwise in the 15% bracket makes little sense. I'd suggest contributing just enough if you were in the 25% bracket to be in the taxable 15% but no more. Use a Roth IRA if you are saving more than that.

I'm adding this based on OP's statement that the fees on the 401(k) range .8-1.4%. I wrote an article Are you 401(k)o’ed? in which I discuss how fees of this range negate the benefit of the mantra "save at 25% to withdraw at 15%" and if one were in the 15% bracket to start, this level off fee will cost you money in no time at all.

The people advising you to max out the 401(k) first, given the rest of your situation and that of the account, are misguided. I'd given them the benefit of the doubt and assume they don't have all the details.

And with all due respect to the other posters here, everyone of them a bright, valued colleague, your answers should be addressed to the OP's exact situation. 15% bracket, no match, high fees. I suspect some of answers will change on reviewing this.

Answer 3

The 401(k) has the advantage that you don't pay any tax until you take it out. That lets the gains multiple.

Two examples:

1. If any of your stocks pay dividends, these are directly taxable if you don't have a 401(k). In the 401(k), the full dividends accumulate and are reinvested.

2. If you sell any stocks and get capital gains, they are also directly taxable in a normal account.

Having said that, if you don't get any match, I would consider doing a 50/50; put half of your money in the 401(k), in something simple like an index fund, and invest the rest. That's assuming you have an index fund available in your 401(k).

Answer 4

easier access to your money

That can be a disadvantage for some people. Based on the number of people who tap their 401K for non-retirement reasons, or just cash it in when they change jobs; making it painful to use before retirement age does keep some people from spending it too early.

They need to be able to compartmentalize the funds in order to understand the difference between funds spending, saving and investing for retirement.

Roth 401K

One advantage that the 401K may have is that you can in many plans invest the funds in a Roth 401K. This allows you to go beyond the Roth IRA limits. You are currently investing the maximum amount in your Roth IRA, so this could be a big advantage.

Answer 5

You hit on the biggest advantage of keeping things out of tax-advantaged accounts: Easier access to the money.

It hurts to take money out of a 401(k) early. It may hurt more in the future. (Do you think the reason the 10% penalty is there in order to protect you from yourself?) It also may be converted into a vehicle besides what you have it in now, due to a "national liquidity crisis."

You have plenty in tax-advantaged accounts, IMO.