401K question / argument

[Rine_Everett]

Let me set this up for you:
Me and the boss are 33 years old
I work for the State, she is a Teacher.
We invest 1,500 in stocks bonds and other funds per month post tax
Our current tax liability is 11% (1 child, 2 years old)
Before our child it was 22%
I say, keep putting the money in like we are doing. My Mom tells me to put it in a 401K.

I argue not to because:
My tax rate now is 11%. After I retire, I am all but assured to be in a higher tax bracket.
Both the boss and I will be eligible for retirement at 50. And will be unable to access all of our funds for about 10 years between retirement and 58.5

Mom argues to put it in the 401K because it is tax free until you draw it out. and thats what suze orman said to do.

I come back with: I am assured to pay 11% right now on the money I put in, after my kiddo drops off my income tax, my tax rate will increase to at least 22% (if not higher). I want to be able to get to all of my money without penalty.

What say the financial heavy weights of 2cool?

Other "things"
house payment: 560/mo (pay 750-1000 though [5.875%] owe less than 80K)
no car payments
RV payment 200/mo (6%, we are way upside down owe 12K)
no credit card debt

[Big John]

First, "tax free" is incorrect. "Tax deferred" is the correct statement. You will pay tax on this money when its taken out. And yes, you should do what your mom told you.

The 401K allows you to make contributions from your income before that income is taxed.

For example (doing it your way), If you gross $10000 per month, and have no pre-tax deductions (which is what a 401K contribution would be), at 11% tax liability you wind up paying $1100 in taxes. Now you are left with $8900 with which you deduct your $1500 for savings. This leaves you with $7400 for everything else.

Now, doing it mom's way, take the same $10000 per month and place the same $1500 per month in a 401K on a pre-tax basis. This leaves you $8500 to which the same 11% tax is applied. At 11% that tax amount comes to $935. This leaves you with $7565 for everything else.

Additional advantages:
If $7400 is all you need for everything else, you have an available $165 that can be placed in savings. Now instead of $1500, you are saving $1665.

Now compare the two amounts:
So, doing it your way and starting with nothing, and assuming a 8% rate of return at $1500 per month for 20 years the ending balance comes out to $889,420.71.

Doing it mom's way, starting with nothing, and assuming a 8% rate of return at $1665 per month for 20 years, the ending balance comes out to $987,257.29.

Mom just made you an additional (nearly) $100,000!
You should remember her well on Mother's Day.

Keep in mind, this is money that you will have in addition to your state pensions and teacher retirement pension.
You'll be just fine.


There are other benfits that might also come into play, but this is the simple answer. My advice, is go seek out a competent financial advisor.

Hope this helps!

[BullyARed]

Originally Posted by Big John

First, "tax free" is incorrect. "Tax deferred" is the correct statement. You will pay tax on this money when its taken out. And yes, you should do what your mom told you.

The 401K allows you to make contributions from your income before that income is taxed.

For example (doing it your way), If you gross $10000 per month, and have no pre-tax deductions (which is what a 401K contribution would be), at 11% tax liability you wind up paying $1100 in taxes. Now you are left with $8900 with which you deduct your $1500 for savings. This leaves you with $7400 for everything else.

Now, doing it mom's way, take the same $10000 per month and place the same $1500 per month in a 401K on a pre-tax basis. This leaves you $8500 to which the same 11% tax is applied. At 11% that tax amount comes to $935. This leaves you with $7565 for everything else.

Additional advantages:
If $7400 is all you need for everything else, you have an available $165 that can be placed in savings. Now instead of $1500, you are saving $1665.

Now compare the two amounts:
So, doing it your way and starting with nothing, and assuming a 8% rate of return at $1500 per month for 20 years the ending balance comes out to $889,420.71.

Doing it mom's way, starting with nothing, and assuming a 8% rate of return at $1665 per month for 20 years, the ending balance comes out to $987,257.29.

Mom just made you an additional (nearly) $100,000!
You should remember her well on Mother's Day.

Keep in mind, this is money that you will have in addition to your state pensions and teacher retirement pension.
You'll be just fine.


There are other benfits that might also come into play, but this is the simple answer. My advice, is go seek out a competent financial advisor.

Hope this helps!

2X. Plus you also have the 401K matching contribution (usually do) and this could add up another $100K. Since you both are young, I would put 80% in 401K and use 20% for stock/bond trading. Take some risk and the reward could be high.

[MikeV]

Originally Posted by Rine_Everett

Let me set this up for you:
Me and the boss are 33 years old
I work for the State, she is a Teacher.
We invest 1,500 in stocks bonds and other funds per month post tax
Our current tax liability is 11% (1 child, 2 years old)
Before our child it was 22%
I say, keep putting the money in like we are doing. My Mom tells me to put it in a 401K.

I argue not to because:
My tax rate now is 11%. After I retire, I am all but assured to be in a higher tax bracket.
Both the boss and I will be eligible for retirement at 50. And will be unable to access all of our funds for about 10 years between retirement and 58.5

Mom argues to put it in the 401K because it is tax free until you draw it out. and thats what suze orman said to do.

I come back with: I am assured to pay 11% right now on the money I put in, after my kiddo drops off my income tax, my tax rate will increase to at least 22% (if not higher). I want to be able to get to all of my money without penalty.

What say the financial heavy weights of 2cool?

Other "things"
house payment: 560/mo (pay 750-1000 though [5.875%] owe less than 80K)
no car payments
RV payment 200/mo (6%, we are way upside down owe 12K)
no credit card debt

Are you implying the child has reduced your tax rate from 22% to 11%? How did you figure that? Assuming a combined income of $70,000, how is the child worth enough (tax wise!) to cut your tax rate in half? You get an exemption, and the $1,000 child tax credit.

Also, if you do retire early, you can get to your retirement funds (in many cases) before you reach 58. As others posted, I would check into what the company match is on the 401(k).

Also, at your age, who knows what tax rates will be in 25 years, or even if we have the same tax system. I think your Mom has the right idea, as long as your investment options (investment choices and frequency with which you can reallocate your investments) are good.

Sounds like you are headed in the right direction. Congrats.

[fishingcacher]

I would fund Roth IRA's for both you and the boss and the remaining amount in a 529 plan for the kiddo.

[RayAM2007]

"TAX DEFERRED" is the key here. No matter how much you put into your 401 over the XX number of years you will still have to pay the 20% up front to the feds every time you make an withdrawl at say 65 years old and greater. And then additional taxes might be levied depending what other income you have, such as social security, part time jobs, etc.

[JimSA]

Originally Posted by fishingcacher

I would fund Roth IRA's for both you and the boss and the remaining amount in a 529 plan for the kiddo.

I would do the Roth if you qualify, but definately do 401k if there is a match. The earnings on a Roth are not taxable upon withdrawl. You mentioned that you are both government employees, so you probably do not have access to a 401k. Its probably a 403b for her and/or similar type pension for you. Ether way, I would definaltey do the pre-tax deferrals with your employer to take advantage of any match, then do the most allowed into a Roth on the rest. Some employer sponsered plans have a roth you can do also. The ones that I set up do. I believe you can also convert your current IRA's to a Roth at your current 11% tax rate, though I do not see how you came up with that. I would assume your tax rate is more like 20%.

[fangard]

There are ways to get money out of an IRA before you are 59.5. See IRS Pub 590. Substantial but Equal Payments(or Rule 72T).