The Fund

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The Fund

Josh explores 401k v Roth IRA’s …. I’m not sure of the specifics around these things, but I presume one taxes money out but not going in and the other is the opposite. I wonder if Josh can tell us which one is better?

Also, by switching to a self-directed retirement account, Josh can indulge his itchy trigger finger and trade with his retirement money. Is this a good thing? Common wisdom would shout “NO!!!!!!’ …. but, where do you stand!?


Like many people employed privately in the United States, I have a employer supplemented 401(k). The match used to be 100% up to 8% of your salary but was recently cut to 50% match up to 8% of your salary.

When I first started at my current position I was contributing 20% pre-tax money to the retirement account, but have since  decreased the contributions to 9% and soon plan to remove it completely once the fund is fully vested in about another year. At that time I will begin contributing post tax money to a Roth IRA.  I haven’t worked through the calculations but I’m estimating a large savings once I retire and begin withdrawing the funds from the Roth tax free, instead of the 401(k).

The factors involved include large growth in fund equity, approximately a 10% early withdrawal fee,  high future taxes and a long period of withdrawal (70 years +).

The current equity in the account is around $12,000, I invested about $11,000 into one particular company this past week and expect it to increase over the next few months. Once I take profits from this trade, I’m going to explore withdrawing the funds from the 401(k) account and depositing the funds into an account which can be withdrawn tax free (due to the recent government stimulus spending, I’m anticipating high taxes in the future).

The performance of the 401(k) fund was terribly poor until I switched from mutual funds into a SDRA (self-directed retirement account), with around 50% loss at the time I switched.  I’ve made one trade since then, realizing a 10% gain. I’m expecting the company I’m in right now to do well, getting me closer to the point where I started, minus the gains I should have incurred since then. Either way,  I’ll let you know how it goes.

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@ Josh – If I read this correctly you’ve dropped down your 401K savings from 20% to 9% with a plan to move to 0%.

What are you doing with the 11% right now and what do you plan to do with the full 20% once you stop the 401K?

Is it all going to a Roth?

I don’t know how much you are investing annually but last I checked individuals could invest 15K/yr in a 401K and 5K/yr in the Roth.

Have you given any consideration to keeping the 401K at 8% to receive the full employer match?

The remaining 12% could then be directed at your Roth or into other investment methods.

It sounds like you’re used to investing 20% of your income. Do your plans keep you at that same level or greater?

One nice thing about keeping your investments based upon a percentage of your income is that each time you get a raise, so does your investment plan.

Good Luck….Jeff

Jeff, great questions,

This is basically what I do every month…
I have the 401(k) funds automaticallly deducted from my pay check into a SDRA, 9% is deducted as of right now. At 9% I’m maxing out the employer contribution which is half of 8% of my income. Since I live at home, whatever extra money I have at the end of the two weeks gets deposited into a brokerage account. It’s usually between 30%-60% of my take home pay that I save every pay check.

I have to explore the options I have for switching retirement accounts from a 401(k) to something else. The reason I would like to do this is so I can pay tax on the money deposited now, and not once I retire, since I will be at a higher tax bracket as well as withdrawing the funds much longer then I am depositing the funds and in much greater amount. This is why I would rather pay tax now, rather then later. This is also the reason why I would like to abandon the employer supplemented 401(k), besides the fact that I have to speak to a finacial planner every time I want to buy a stock that costs less then $5 per share, which is usually the kind of companies I buy, this gets really annoying.

True about the automatic increase once your income goes up, when I stop contributing to the 401(k) I’ll have to change the automatic contributions myself into my brokerage account instead of the 401(k). This way I won’t even be tempted to spend it.

I don’t know about you guys, but most folks I know who have retired make LESS than they did when they were making money. That could place you in a lower tax bracket than at your peak earning years (which is probably more Jeff’s age than Josh’s). Definitely dpends on what tax bracket you expect to be in when you retire as to whether or not you want to pay taxes now – while earning – or later – once retired.

@Jeff, part of what he is doing with the 11% is paying his taxes on that money. So, it’s pay now or pay later and you figure out which is going to cost you more (a calculatable NOW figure, or a guesstimate for 20-30 or 50 years down the road).

@Josh – One of the challenges with 401K is that you are often at the mercy of the “plan” that the company chose for you. In my case I’m fortunate because the government actually has a nice variety of low cost index funds to invest in.

With your trading/individual stock approach a self directed traditional or Roth IRA would probably be better suited to your desires.

If you want to pay the tax now and grow/withdraw tax free then a Roth IRA would be the retirement account to use. I think the 2009 limit is still at $5000.

The money you already have in the 401K can be Roth-ized. You’ll want to check with a tax adviser/accountant to be certain. I’m not sure if you can convert directly from a 401K to a Roth, but you could probably roll over the 401K to a traditional IRA and then pay the taxes required to turn the traditional IRA into a Roth IRA. At that point, you should be able to trade to your heart’s desire and take withdrawals later in life tax free.

Of course that is only if the government doesn’t change the rules on us and decide they need to tax it anyway in order to help pay off our national debts.

One comment you made peaked my interest…

“once I retire, since I will be at a higher tax bracket as well as withdrawing the funds much longer then I am depositing the funds and in much greater amount.”

Does this statement mean that you intend to start withdrawing the money when you “retire” after reaching your number? If that’s the case you may have to pay a penalty for early withdrawals since these accounts are typically based upon withdrawals after reaching your sixth decade of existence.

@ Josh – Great discussion on stuff that I know very little about – tax-advantaged accounts: 401k’s, ROTH (with or without Irish terrorist organizations), etc.

What I CAN say is this:

1. You have the aptitude and desire to move your money around, so it needs to be something that you can self-direct into the investment types of your choice (check that the laws actually allow you to trade in each specific type of account that you are looking at), and

2. It’s unlikely, as Jeff suggests, that you will be leaving your money in there until 60 (unless some other event takes over that makes the amount that you have in there redundant).

So, you will want to talk to a good tax accountant (NOT financial adviser, who will only understand one relationship: tax-advantage = buy/hold mutual funds) about the pro’s / con’s of each.

I also suggest that when you compare the benefits of tax-in v tax-out that you assume withdrawals starting from your Date … and, from your comments, I think this is what you had in mind, anyway?

Oh, and don’t forget to factor in employer match for as long as you think you’ll be working …

Caution: your trading strategy is, inherently, high risk … it will either succeed or it won’t (put whatever % probability you want against each possible outcome, but I always just assume binary – no matter how good the odds seem).

So, some would argue that you should keep your ‘retirement account’ as backup, just in case … I didn’t, but that doesn’t mean that you should / shouldn’t … it’s a personal ‘risk related’ choice. Of course, if you do keep your account until ‘retirement’, you may have to find other places to raise capital to fuel your Growth Engine 🙂

@ Jeff, I’ve been reseaching the Roth, seems if you can take sizeable withdrawls 1 X per month or more, you can begin withdrawing the funds before 59 1/2 without the penalty, buy I have my tax accountant to tell me if this is true or not, I’ll keep you abreast.

@ Adrian, I’m running this ship in a way to retire at 31, there is no alternative. This is just a part of the plan, as time goes on, trading will turn more into a business once I begin to invest other people’s money.

[…] Josh – On the other end of the age/work scale is Josh, who still has the ‘luxury’ of living at home with his folks: free rent = more to save (or spend?). Should Josh even be saving in a system that doesn’t allow him free’n’clear access to his money until he is 3 times his current age? And, should Josh be using his ‘retirement account’ in the Grand Casino that is the Options Market? […]