Retire Early Home Page Discussion Board

[Nick]

Question:

Am i Wrong in assuming the following:

Given that the return of the funds are equal, am I better off not contributing to my employer's 401K fund given the following:

There is no employer match.
The lowest expense ratio of available funds is 1.32.
My effective tax rate is 21.6 (marginal 28.0).
VFINX expense ration is .15.
30 years until age 65.

Do I forgo the 401K and invest money in an index fund like VFINX, even though there is no tax advantage? My math tells me yes, but would like other opinions...

[sgeeeee]

You still earn money tax deferred in the 401(k) and the earnings add up faster than they would in a taxable account (since the base amount you earn on is not depleted by annual taxes). This can add up to a lot of money over a few decades.

If you have enough time to accumulate savings in the 401(k), and the funds are appropriate for your portfolio, then you will probably come out ahead using the tax deferred option. But if you only have a few years and/or the 401(k) funds are not really funds you would like to invest in, those higher fees might overwhelm the tax advantage.
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-=sgeeeee=-

[Nords]

[sgeeeee]

I got a chance to run some numbers for the specific case you mention.

CASE 1 -- taxable account assumptions:
deposit $3000 per year for 30 years,
then withdraw $3000 per year for 30 years.
earn 7% per year
expense ratio of 0.15% per year
tax rate on earnings 21.6% pre-retirement, 18% post-retirement
no tax on withdrawals.

CASE 2 -- tax deferred account assumptions"
deposit $3000 per year for 30 years,
then withdraw $3000 per year for 30 years.
earn 7% per year
expense ratio of 1.32% per year
tax rate on earnings 0% pre-retirement, 0% post-retirement
withdrawals taxed at 18%.


After the 30 years of accumulation, the tax deferred account contains $240,000 while the taxable account contains $227,000

During the withdrawal phase, the tax deferred account remains higher than the taxable account for only 5 years. By year 60, the taxable account contains $1.36M while the tax deferred account contains $994,000.

That 1.32% expense ratio is a killer. For the cases listed above, your mutual fund would have to earn ~13% per year (rather than the 7% assumed) for the tax deferred account to come out ahead.


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-=sgeeeee=-

[Nick]

Thanks! This website has been a great resource. Thanks, sgeee for taking the time...