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This question has been asked before but the situation I have is not well covered - hence a new question.

Mid-to-late 50s. High tax bracket. Roth not an option; post-tax IRA only. Fair-sized tax deferred portfolio ~2M counting spouse's. Have a fair but smaller post-tax portfolio too. Generally speaking, live well but modestly and a saver. So, not investing in 401k doesn't mean not investing that income.

The employer plan has high expense ratio. For instance, VG index funds available at 0.09% expense ratio from VG is offered at 1.23%. Have complained but it is a take it or leave it situation.

What would you advise and why.

Many thanks!

Additional comments:

  • No company match.
  • Number of years till retirement: unclear. Can afford to, but also like my work. Perhaps safe to say between 5 to 10.
  • Does the company permit in-service distributions after a certain age, usually 55+? – JoeTaxpayer Nov 5 '16 at 14:38
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It's tough to talk about taxes without having the brackets handy. I wrote about the 2017 rates as they were just announced.

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The benefit of the 401(k) is the tax deferral and potential shift in brackets, e.g. I deposited most of my working life at 25%/28% but am retired and withdrawing at 0/10/15%. I worked for a large company, with an index cost currently .02%/yr. In your case, we are looking at the trade-off of using a 401(k) with a fee I consider criminal, 1.23%.

You say "high" current bracket, I'll assume 33%. To be clear to readers, you don't pay 33% on all, or even most, of your income, only the taxable income over $233,350. Your $14,925 costs you $10,000 to deposit this year. Instead of tossing number out, which quickly gets tough to follow here's a spreadsheet -

enter image description here

I start by assuming we will look at the decision 10 years hence. The market return is 8% (less the 1.23%). The tax bracket going in (i.e. your current bracket) is 33%. Then after 10 years, this money is subject to 25% tax. This is the rate I'm expecting, given your current retirement account. Then, we analyze to see the result if invested post tax, the net $10,000, with a return of 7.9% (same as the 8% but a .1% fee), but with the 15% cap gain rate.

You can see that the value of putting the money in while in the 33% bracket, but withdrawing at 25% is not negated completely by the fee. Not even after 15 years. Surprisingly, even depositing at 28%/ withdrawing at 25% is worth it if you pull the money out after 10 years. At 15 years, that scenario fails slightly.

In my answer I only address the choices of using the 401(k) vs a post tax account. And my answer, essentially, "It depends" is a function of (a) time, (b) return, and (c) bracket in/ bracket out. You can use a spreadsheet to enter your own assumptions.

If you have no pre-tax IRA money right now, by all means, do the back-door Roth, while this loophole remains open.

Last - if the sheet I posted here isn't clear, comment, and I'll update for clarity.

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I face this same issue, unfortunately. It's too bad companies can't manage to arrange good collections of funds and negotiate good expense ratios.

About your Roth Situation. You probably can contribute to a Roth using the backdoor Roth method. Contribute post-tax to a traditional IRA and then roll it into a Roth. There's no income limitation on this. The only catch is that you can't have any outstanding traditional IRAs when you do it. You can solve this by rolling them into your 401(k) first. Though that raises the problem that your 401(k) is bad.

How to improve your 401(k) options. Many 401(k) providers give you a list of funds that you are allowed to invest in based on what your company allows and it contains a poor selection. But you can also sign up for an account with the provider and manage your account directly. Using this method you can often move your money into funds not approved by your retirement plan committee. I mention this because it is true for me and it has made my retirement investments so much better since I figured it out.

What to do if none of this works. I don't know what your tax rates will ultimately be during retirement but I think it probably still makes sense to contribute to your 401(k). Max it out if you can. One percent plus is a pretty high rate to pay on a mutual fund, but that cost seems small compared to the 25%+ of your money Uncle Sam will take if you don't contribute to your 401(k)--or rather the difference between your current tax rate and the average tax rate during your retirement years. Look at all your options and invest in the lowest cost fund.

Good luck.

  • Thank you! This is useful. I know about the backdoor Roth conversion. It works well for my wife but not me (as part of the conversion becomes taxable, according to my accountant. Will look into the possibility of managing my account directly, though am not optimistic. – kavm Nov 5 '16 at 15:47
  • I expect that the reason it would be partially taxable is that you need to roll your traditional IRA's into a 401(k) first. My solution was to open a 401(k) for my "self employment" income. That income isn't much but I was able to open a solo 401(k) at Fidelity that allowed incoming rollovers--Vanguard doesn't. It was free and has great funds. Mow some people's lawns or something, get an EIN, report it on schedule C, and open yourself a solo 401(k). You don't need a large self-employment income to do this. – farnsy Nov 5 '16 at 15:57
  • Unfortunately, the solo-401k route is closed for technical reasons. I am very familiar with them and have had a couple. However, we have had to reorganize the company to employee model due to Obamacare related concerns. So, unfortunately - that path too is closed. What I was wondering was whether saving post-tax and paying lower capital gains is superior to 401-k under certain circumstances (e.g. high cost funds, modestly long horizon). I suspect the tax rate differential is the dominating factor but was looking for ideas or confirmation. – kavm Nov 5 '16 at 20:44

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