401(k) and Investing

[jIM_Ohio]

Originally Posted by Scanner

Jim,

I hadn't thought about Roth IRA fees entering the equation. Good point.

Peak earning years are generally 35 to 55. . .so I am not sure we can make too much judgement on what the earning potential of this couple is. One is a teacher - that says to me that there will be a pension 25-30 years down the road, much earlier than 65 y.o. I think pensions are taxed as income so it's why my gut went with the Roth.

I know you mean well by punching the numbers but I think you are overwhelming him here.

I think you told me that a Roth has a potential for prinicipal withdrawal and there's a good chance they'll need that for something someday (house, medical bills, college, home improvement). The 401(k) is entirely hands off.

BTW, I'm the one with commodities - no biggie. You and Steve are the CEO guys My silver recoverd like .25% today, LOL.

At age 24, he would be in zero % tax bracket with what he has saved, Roth is not realistic advantage. His primary issue (IMO) is he needs to save more (and not worry about taxes NOW).

31k of income is in 15% tax bracket, and he can make up to 61k (double his income) before he hits a higher tax bracket. I don't think Roth makes full sense, unless OP KNOWS with high certainty, he'll be making more than 70k per year real soon.

The pension and fiance being a teacher did factor in... but it did not "overwhelm" me to adjust advice above (with info available).

If a checkpoint is reached with a 9% assumed return, I think OP would be a candidate for early retirement, and then the Roth needs to ramp up.

This would be tax free income in retirement and access to this money is possible for early retirement. A 401k could have access via a loan (which I think is better than a Roth withdraw). Under proper circumstance (I have used 401k loans twice when I needed money). It's like a bond fund in 401k with me paying the interest to myself. From a tax standpoint it's not a good deal, but it's a way to leverage the assets one has.

[disneysteve]

Originally Posted by Scanner

BTW, I'm the one with commodities - no biggie. You and Steve are the CEO guys

I do have a gold and precious metals fund if that counts.

[Big G]

Originally Posted by jIM_Ohio

If a checkpoint is reached with a 9% assumed return, I think OP would be a candidate for early retirement, and then the Roth needs to ramp up.

I'm not going to lie, a lot of this is going over my head but I like the sound of early retirement

[jIM_Ohio]

I posted this somewhere else, but saving pretty much favors the person which starts first, all things being equal.

Assume you and me, making the same amount. You are 24, I am 34.

You save $1000/yr and earn 10% a year. You save $1000/yr for ages 24-34 (11 years). You set aside $11,000 of your income. 10% return every year, at age 65 you have ~$391,000.

I save $1000/yr from age 34-54 (21 years). $21000 total. I saved twice as much as you (but started 10 years later). 10% return (same as you), ending at age 65 (same as you). I ended up with ~$200,000.

You set aside HALF as much and started only 10 years before me, but ended up with TWICE as much. Investing always favors people which start younger. That is why I use the checkpoints... to see where I am as far as "investing early".

For me to equal your final number, I would need to invest $1950 for the 21 years ($41,000 total). So I need to invest almost 4X as much to catch up. The goal is to "be ahead" and not play catch up.

[kv968]

Originally Posted by jIM_Ohio

This would be tax free income in retirement and access to this money is possible for early retirement. A 401k could have access via a loan (which I think is better than a Roth withdraw). Under proper circumstance (I have used 401k loans twice when I needed money). It's like a bond fund in 401k with me paying the interest to myself. From a tax standpoint it's not a good deal, but it's a way to leverage the assets one has.

I think we all agree that borrowing or withdrawing any money from a retirement account should be viewed as a "last-ditch effort" to get money. However sometimes it has to be done but taking a loan out of a 401k is something to be avoided IMO. Taking money from a Roth isn't good either because you can't put that money back due to yearly maximum contribution limits but there are more pitfalls with a 401k loan. Besides the "double-taxation" aspect of it, you also put yourself at great risk if you should leave the company while the loan is outstanding. If you don't pay it back within a set amount of time (usually 60 days) of leaving the company, the loan is then considered a premature distribution and would be taxable and subject to the 10% early withdrawl penalty if you're younger than 59 1/2.

did...he...just...say...double-taxation?!


RUN!

[jIM_Ohio]

Originally Posted by kv968

I think we all agree that borrowing or withdrawing any money from a retirement account should be viewed as a "last-ditch effort" to get money. However sometimes it has to be done but taking a loan out of a 401k is something to be avoided IMO. Taking money from a Roth isn't good either because you can't put that money back due to yearly maximum contribution limits but there are more pitfalls with a 401k loan. Besides the "double-taxation" aspect of it, you also put yourself at great risk if you should leave the company while the loan is outstanding. If you don't pay it back within a set amount of time (usually 60 days) of leaving the company, the loan is then considered a premature distribution and would be taxable and subject to the 10% early withdrawl penalty if you're younger than 59 1/2.

401k loan vs Roth principal withdraw. Pros and cons to each.

A 401k loan acts like a mid term bond with interest payments being made by borrower to themself. These payments are taxed, the end result is a higher balance in 401k. 50% of a 401k, upto 50k, can be borrowed based on what I've know.

A Roth withdraw is limited to principal contributions, and cannot be replaced (once withdraw, you have 60 days to replace?). The Roth contributions were already taxed.

Pros/Cons

401k
Pros- higher account balance once loan is paid off
higher available withdraw (unless someone has contributed 50k over 12.5 years to Roth)

Cons
Double tax

Roth
Pros
simpler?

Cons
Cannot replace what you withdrew
Lower relative amount you have access to (unless Roth is 12+ years old and you have contributed more than 50k).

I have borrowed from my 401k twice (once for each house we bought).

First loan was 7k over 7-8 years and I regret the term of the loan.
Second loan was 19k over 14 months. Repaying quickly is a huge positive step towards avoiding double taxation over an extended period of time.

[kv968]

Originally Posted by jIM_Ohio

A Roth withdraw is limited to principal contributions, and cannot be replaced (once withdraw, you have 60 days to replace?). The Roth contributions were already taxed.

Once the money is out of Roth you can't replace it. If you take say 10k of your contributions out, you're still not allowed to go over the yearly maximums to replace it. That's why it's not really good to take money out of a Roth either.

What I was referring to when I wrote about the "60 days" was that's the usual time you have to pay back a 401k loan if you leave the company before it's considered a premature distribution.

Originally Posted by jIM_Ohio

I have borrowed from my 401k twice (once for each house we bought).

First loan was 7k over 7-8 years and I regret the term of the loan.
Second loan was 19k over 14 months. Repaying quickly is a huge positive step towards avoiding double taxation over an extended period of time.

I borrowed from my 401k years ago and actually I think I may have made money on the deal since what I was holding in my 401k at the time totally tanked while the loan was out Even so, I wouldn't borrow from it again, I just didn't know any better at the time.

[jIM_Ohio]

[quote=kv968;106406]Once the money is out of Roth you can't replace it. If you take say 10k of your contributions out, you're still not allowed to go over the yearly maximums to replace it. That's why it's not really good to take money out of a Roth either.

What I was referring to when I wrote about the "60 days" was that's the usual time you have to pay back a 401k loan if you leave the company before it's considered a premature distribution.

[quote]

I think their is a provision, within one of the types of IRAs, to withdraw principal, and put it back in within a short period of time.

looks at IRS site now... if I find something, I'll post a link.

[kv968]

Originally Posted by jIM_Ohio

I think their is a provision, within one of the types of IRAs, to withdraw principal, and put it back in within a short period of time.

looks at IRS site now... if I find something, I'll post a link.

Please do.

[jIM_Ohio]

Originally Posted by kv968

Please do.

I couldn't find what I thought I knew.

So that means I knew less than I thought.

That does not happen often

[kv968]

Originally Posted by jIM_Ohio

I couldn't find what I thought I knew.

So that means I knew less than I thought.

That does not happen often

Just because you can't find it doesn't necessarily mean you don't know it. I know there's many things I've come across that I wish I remember where I saw it so I could reference it. If I happen to come across anything in my travels about putting back IRA withdrawls I'll let you know. I tend to think though that it's not allowed. I guess in the meantime, let's just not touch our IRA's and have to find out for ourselves

[humandraydel]

Originally Posted by kv968

Besides the "double-taxation" aspect of it

You do realize that this is not true, right? Sorry, this misunderstanding is just a pet peeve of mine!

[kv968]

Originally Posted by humandraydel

You do realize that this is not true, right? Sorry, this misunderstanding is just a pet peeve of mine!

You pay the loan back with post-tax money and then you get taxed again when you take it out. Maybe I'm missing something, but how is that not some form of "double-taxation"? Please explain.

[humandraydel]

Originally Posted by kv968

You pay the loan back with post-tax money and then you get taxed again when you take it out. Maybe I'm missing something, but how is that not some form of "double-taxation"? Please explain.

Well, you are forgetting that the money loaned to you was TAX FREE. I'll try to explain, but it seems most people have difficulty understanding this.

Imagine you want to spend $1,000 on a plasma TV. You have two options (assume 25% tax bracket):

1. Make $1,350 dollars resulting in ~$1,000 after taxes. Buy TV.

2. Take out 401k loan for $1,000. Buy TV. Repay 401k by making $1,350 pre-tax dollars.

Either way, you must make $1,350 pre-tax dollars to pay for a $1,000 after tax dollar expense. Also, in both scenarios your 401k balance does not change.

Alternatively, consider the scenario in which you borrow $1,000 from your 401k to buy a TV. Being the frugal person you are, you decide to wait a week and see if your desire subsides After a week you decide you don't need the TV, and repay the $1,000 401k loan. You incurred no extra taxes by doing this.

[kv968]

Originally Posted by humandraydel

Well, you are forgetting that the money loaned to you was TAX FREE. I'll try to explain, but it seems most people have difficulty understanding this.

Imagine you want to spend $1,000 on a plasma TV. You have two options (assume 25% tax bracket):

1. Make $1,350 dollars resulting in ~$1,000 after taxes. Buy TV.

2. Take out 401k loan for $1,000. Buy TV. Repay 401k by making $1,350 pre-tax dollars.

Either way, you must make $1,350 pre-tax dollars to pay for a $1,000 after tax dollar expense. Also, in both scenarios your 401k balance does not change.

Alternatively, consider the scenario in which you borrow $1,000 from your 401k to buy a TV. Being the frugal person you are, you decide to wait a week and see if your desire subsides After a week you decide you don't need the TV, and repay the $1,000 401k loan. You incurred no extra taxes by doing this.

Nice analogy, but you didn't take it out quite far enough. I understand what you're saying, but you're not taking into consideration the tax you pay on the money you take out of the 401k when you retire.

1. You borrow $1,000 from your 401k
2. You pay back the $1,000 loan with $1,350 pre-tax since it'll be out of post-tax money(assuming 25% tax bracket and not worrying about the interest)
3. When you take out that $1000 later when you retire you are taxed on it as normal income.

Step #3 is when the double taxation comes into play. You were taxed on that money in step #2 before you paid back the loan with it and now again in step #3 when you take it out in retirement.

The amount in your 401k also changes. Take $1000 dollars out, and that's $1000 less in your 401k until you pay it back.

The alternative scenario is correct though because you're paying the money back with the same money you took out without getting anything for the money. You didn't use it for anything so there's no transfer of goods. For example, you give me 10k and I give it right back to you. I gain nothing from that transaction because I didn't get anything from it. If you give me 10k and I buy something with it, the money's gone, the product or whatever is mine but now I have to come up with 10k to give you. And that 10k will be money I made after taxes were taken out. The only difference in this scenario is you won't be giving that 10k back to me in retirement where it will get taxed again. Although you could if you'd like

And besides, the desire wouldn't subside with a plasma TV

[humandraydel]

Originally Posted by kv968

Nice analogy, but you didn't take it out quite far enough. I understand what you're saying, but you're not taking into consideration the tax you pay on the money you take out of the 401k when you retire.

1. You borrow $1,000 from your 401k
2. You pay back the $1,000 loan with $1,350 pre-tax since it'll be out of post-tax money(assuming 25% tax bracket and not worrying about the interest)
3. When you take out that $1000 later when you retire you are taxed on it as normal income.

Step #3 is when the double taxation comes into play. You were taxed on that money in step #2 before you paid back the loan with it and now again in step #3 when you take it out in retirement.

And step 3 is exactly where everyone gets so confused about this issue. In reality, step 3 is a non-issue. Take my two scenarios through step 3 - but remember, at step 2 both had the same 401k balance. So at step 3 BOTH scenarios will pay exactly the same tax. Also note that, prior to step 3, both scenarios had already paid the same tax - $350 on a $1,000 purchase. It's really just a matter of when that first $350 tax is paid.

[humandraydel]

Don't forget: the $1,000 401k loan was TAX FREE money. As we all know, the government doesn't like giving you tax free money! So you have to pay the tax on it, you just do it when repaying the loan. It works out exactly the same as if you had just grossed $1,350 to net $1,000.

Now, to make things even more confusing: the INTEREST that you pay yourself IS taxed twice. This is because you "pay yourself" interest with after tax dollars. And the interest will be taxed when you withdraw it in retirement - but at least it got 20+ years of tax deferred growth!

[jIM_Ohio]

Originally Posted by kv968

Nice analogy, but you didn't take it out quite far enough. I understand what you're saying, but you're not taking into consideration the tax you pay on the money you take out of the 401k when you retire.

1. You borrow $1,000 from your 401k
2. You pay back the $1,000 loan with $1,350 pre-tax since it'll be out of post-tax money(assuming 25% tax bracket and not worrying about the interest)
3. When you take out that $1000 later when you retire you are taxed on it as normal income.

Step #3 is when the double taxation comes into play. You were taxed on that money in step #2 before you paid back the loan with it and now again in step #3 when you take it out in retirement.

The amount in your 401k also changes. Take $1000 dollars out, and that's $1000 less in your 401k until you pay it back.

The alternative scenario is correct though because you're paying the money back with the same money you took out without getting anything for the money. You didn't use it for anything so there's no transfer of goods. For example, you give me 10k and I give it right back to you. I gain nothing from that transaction because I didn't get anything from it. If you give me 10k and I buy something with it, the money's gone, the product or whatever is mine but now I have to come up with 10k to give you. And that 10k will be money I made after taxes were taken out. The only difference in this scenario is you won't be giving that 10k back to me in retirement where it will get taxed again. Although you could if you'd like

And besides, the desire wouldn't subside with a plasma TV

step 2 is incorrect, my 401k loans have been paid with after tax money.

The $1000 principal is not taxed going into 401k. It is paid back with "after tax" money, so their is taxed money inside the 401k.

The $350 interest has been taxed, is inside 401k, and will be taxed on the way out.

[kv968]

Originally Posted by humandraydel

Don't forget: the $1,000 401k loan was TAX FREE money. As we all know, the government doesn't like giving you tax free money! So you have to pay the tax on it, you just do it when repaying the loan. It works out exactly the same as if you had just grossed $1,350 to net $1,000.

Now, to make things even more confusing: the INTEREST that you pay yourself IS taxed twice. This is because you "pay yourself" interest with after tax dollars. And the interest will be taxed when you withdraw it in retirement - but at least it got 20+ years of tax deferred growth!

I see what you're saying. I was trying to explain something different. I was trying to say that taking a loan from your 401k period would result in double taxation. However, as you pointed out, if you were to take the loan elsewhere instead you'd still be paying it back with post-tax dollars. My scenario was kind of a either you take a loan from your 401k or you don't take a loan from anywhere at all. I'm sure that doesn't make sense but it's getting late.