NinjaPigeon - My Flight to Financial Independence

Friday, July 07, 2006

401k - the tax gamble

RunBlog made a post asking if it was better to invest in a 401k or to pay the taxes now and save in other ways.

His quote about the radio station, in my opinion, only shows their failure to see the big picture. They suggested paying the taxes now.

My answer? Do both.

There is no smoking gun to retirement savings. Fact is we don't know what will happen to our 401k programs or to our new-found love, the Roth IRA. So how do we, as future retiress, plan for such things? By diversifying our assets across retirement vehicles just as we do across asset classes.

So, contribute to your 401k. If you have money left over after reaching the company match, contribute to a Roth if you are eligible. Still got money left? How about investing in some low-expense mutual funds? Still more? Tax-friendly municipal bonds or a treasury bill perhaps?

Remember that 401ks also provide some other benefits that make them attractive even if you think you should take the tax-hit now. There is the forced savings that RunBlog mentioned. Also, for those of you close to a income-tax bracket, they can help you get under it by lowering your Adjusted Gross Income(AGI), avoiding a higher tax rate. By that same token they lower your Modified Adjusted Gross Income (MAGI), which is the number used to determine Roth IRA eligibility. They also allow you to potentially get free money through company matching of contributions.

Make sure as you are exploring these different places to put your money that you don't forget to keep some of it in guaranteed accounts, such as CDs or savings accounts. You don't want all of your money tucked away where you can't get to it if you are able to retire early!


  • I contribute extra money to my 403(b) even though my Roth is not maxed out because my AGI is close to $25k. Under $25k you get a 10% tax credit for any retirement money you contributed - so not only do I pay less taxes on the money in the first place, I get 10% of that money back anyway. It's definitely worth it for those of us near that line - and even more worth it if you are way UNDER that line since you get an even bigger credit.

    By Blogger Kira, at 7/07/2006 9:39 AM  

  • Another point to consider is if you have no matching and feel the tax rates will be higher when you retire then you may not want to give up the direct control over the money. Finally , what choices your plan has may affect your decision.

    By Blogger RunBlog, at 7/07/2006 4:57 PM  

  • Good point on the tax rates. I can't speak for other professions, but in mine, I think it's somewhat common to be in a high income bracket very early on.

    As for control over the money, if you are lucky, your 401k provider will sometimes allow you to choose from a more broad selection of funds, for a small fee. Fidelity offers a service called BrokerageLink with a quarterly fee of $5 that gives you access to all of their funds, many of which you can purchase with no load.

    By Blogger NinjaPigeon, at 7/07/2006 5:14 PM  

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