Food for thought on 401(k)s

Food for thought on 401(k)s	justaregularguy	12/28/2007 11:33:33 PM
Regardingthe debate about 401ks, I decided to crunch some numbers. There are acouple assumptions I will discuss. First, with apologies to Rasputin, Iassume here that the options are either invest in mutual funds in a401k or invest in mutual funds outside tax preferences. This is thereality for many people who do not have the time, size of portfolio, orexpertise to actively invest. So, I am testing tax preference nowversus fear of tax increases later. This might help to provide somefigures so as to then later on compare, say, the strategies of low-feeindex mutual funds versus burying silver eagles in coffee cans. ASSUMPTIONS 401kguy: invests $10,000 per year in monthly pre-tax contributions,employer matches $1,500 per year, contributes for 35 years thenwithdraws evenly to zero balance in ten years. Interest earned is 5%annual on monthly balance. Withdrawals are taxed at a 40% tax rate. No401k guy: invests $10,000 per year in monthly contributions (actuallyworth $7,800 after tax), no employer matching, contributes for 35 yearsthen withdraws evenly to zero balance in ten years. Interest earned is5% annual on monthly balance. Contributions and interest are taxed at a22% tax rate as current income. No tax on withdrawals. RESULTS 401k:$350,000 in contributions, $52,500 matching, $983,000 interest earnedfor a total available of $1,388,000. Tax on withdrawals is $565,000, sonet cash proceeds for retirement is $833,000. No 401k: $273,000in contributions after paying income tax, $666,000 interest earned fora total available of $942,000. Tax on interest is $147,000, so net cashproceeds for retirement is $795,000. Key assumption: 22% current tax rate versus 40% in 35 years. 401k still previals, but modestly. Have at it…
RE: Thanks, Justa, for that analysis.	rasputin	12/29/2007 3:29:51 AM
Now, please allow me to respond with what I REALLY believe. Thedebate between "investing" inside a 401(k) sheeple pen and outside thepen (but still within the fiat/fractional reserve/centralbank/securitization/derivatives system) is tantamount to discussingwhich set of table and chairs looks best on the Titanic. For, as long as one is operating withing this corrupt, failing, system, they are subject to being wiped out. Now, having stated that point, please allow me to drill down a little further into your well-thought-out post: (Justa):This is the reality for many people who do not have the time, size of portfolio, or expertise to actively invest. (Ras):Andright there is one of the HUGE disadvantages that the sheeple are atversus Wall Street and DC, who are the ultimate "insiders" in thisgame. Therefore, the lambs should NOT participate in any scheme set upby these groups. Now, before Mad Ludwig jumps in and offers hisapologist view on the system, please allow me to offer this analogy:Mad Ludwig's situation is similar to someone who was in early on aPonzi scheme and was able to cash out before the pyramid collapsed.They are all for it. However, it's the forty-five million other lambsthat will be left holding the bag when they try to cash out over thenext twenty years and find out that their assumptions that the stockmarket will only and forever rise to the sky, based on ever-greaternumbers of suckers coming in on the back end were completely incorrect. (Justa)So,I am testing tax preference now versus fear of tax increases later.This might help to provide some figures so as to then later on compare,say, the strategies of low-fee index mutual funds versus burying silvereagles in coffee cans. (Ras):Excellent criteria, but not the onlyone. One must ALSO figure in little details such as extended bearmarkets where the value of the portfolio might be underwater for YEARSor DECADES, but for now let's run with it. (Justa:)ASSUMPTIONS 401kguy: invests $10,000 per year in monthly pre-tax contributions,employer matches $1,500 per year, contributes for 35 years thenwithdraws evenly to zero balance in ten years. Interest earned is 5%annual on monthly balance. Withdrawals are taxed at a 40% tax rate. (Ras):Stopright there, Justa. That ASSUMPTION that the employer will match,year-after-year, every year, in the same amount, despite all the ups,downs, vagaries, and uncertainties facing businesses is a dangerous oneand would MAJORLY, MATERIALLY affect the outcome. Many employersstopped matches in 2000-2002, so there is empirical proof that thematch is NOT guaranteed. Furthermore, many matches are in company stockwhich is ALSO subject to vicious drops in price. (Justa)No401k guy: invests $10,000 per year in monthly contributions (actuallyworth $7,800 after tax), no employer matching, contributes for 35 yearsthen withdraws evenly to zero balance in ten years. Interest earned is5% annual on monthly balance. Contributions and interest are taxed at a22% tax rate as current income. No tax on withdrawals. (Ras):Andfurthermore, this person HAS COMPLETE LATITUDE TO PULL OUT THE FUNDS,HIDE THEM IN THE MATTRESS, BUY BUGGY WHIPS, GOOG STOCK OR ANYTHING ELSEHE/SHE WISHES WITHOUT "BIG-BROTHER" TELLING HIM/HER "WE WILL PENALIZEYOU FOR TRYING TO PROTECT YOUR MONEY!!!" (jUSTA):RESULTS 401k:$350,000 in contributions, $52,500 matching, $983,000 interest earnedfor a total available of $1,388,000. Tax on withdrawals is $565,000, sonet cash proceeds for retirement is $833,000. (Ras):See reply below (Jusat):No401k: $273,000 in contributions after paying income tax, $666,000interest earned for a total available of $942,000. Tax on interest is$147,000, so net cash proceeds for retirement is $795,000. (Ras):Pleasenote that Justa used what I believe to be a VERY low tax rate goingforward for the sheeple stuck in the 401(k) pen. What if tax rates are50%? Or 60%? Or 70%? don't think it could happen? Think again. Becausetax rates were upwards of NINETY PERCENT during the 'fifties and'sixties. And they certainly can go that high again, especially as thegovernment gets increasingly desperate for funds.Also, Justa's analysiscompletely ignores the MAJOR issue of the retirement administratorsclipping the flocks to death for fees, bid-ask spreads and otherscams--which could reduce the portfolio by as much as thirty percent. (Justa):Key assumption: 22% current tax rate versus 40% in 35 years. 401k still previals, but modestly. (Ras):Nofurther comment on that part. But, one, final parting shot: Again, Iask the bears on this board, are you a sheeple that NEEDS to be told byyour Big Brothers in DC and Wall Street to follow their plan (lobbiedfor by big business and hijacked by Wall Street) and stay in theirpens, or do you have the discipline and temerity to take care ofyourself? If your answer is "I need somebody else to tell me what todo, to spoon-feed me (limited) investment choices, clip me for fees thewhole time, and penalize me if I want to take MY money from My accountand do what I want with it", then you will get exactly what you deserve.
RE: Thanks, Justa, for that analysis.	Mad Ludwig of Bearvaria	12/29/2007 6:58:58 AM
"Because tax rates were upwards of NINETY PERCENT during the 'fiftiesand 'sixties. And they certainly can go that high again, " MarginalUS income tax rates on modest retirement incomes have never beenanywhere near 90%, although the top rate on those with high taxableincomes has been and may well be again. Anyone who ends up paying90% of 401(k) withdrawal money in taxes will have no trouble paying forhis choice of the best canned cat food available to retirees, but themasses who end up 100% dependent on Social Security after they can nolonger work will wish they had put something into a 401(k) or similarplan when they had the chance, and the distributions they would get ifthey had such savings would likely be subject to no tax at all, otherthan the 25% sales tax on dry dog food that everyone will have to payanyway no matter where their money comes from.
RE: Thanks, Justa, for that analysis.	Mad Ludwig of Bearvaria	12/29/2007 7:11:32 AM
"(Ras):Stop right there, Justa. That ASSUMPTION that the employer willmatch, year-after-year, every year, in the same amount, despite all theups, downs, vagaries, and uncertainties facing businesses is adangerous one and would MAJORLY, MATERIALLY affect the outcome. Manyemployers stopped matches in 2000-2002, so there is empirical proofthat the match is NOT guaranteed. Furthermore, many matches are incompany stock which is ALSO subject to vicious drops in price. " Ifthe employer stops matching contributions to the degree you require tomake a 401(k) better than alternative uses for the money, just stopcontributing! The employer contributions made based on earliercontributions will still be there. Where matches are made incompany stock, you may lose all or most of it, or your employercontributions account may increase by a factor of ten in one year ifthe stock pops. You can hedge with puts outside the 401(k) if you havea large employer stock account and think the end is near. For thosecloser to retirement, many employers who match contributions in Co.stock allow older employees to sell the stock and put it into somethingsafer.
RE: Thanks, Justa, for that analysis.	justaregularguy	12/29/2007 7:47:52 AM
Youknow, I don't disagree with most of what you say. I almost perfectlyshare your critique of the rigged game and also bleak analysis of whata worst case scenario might look like: I read James Kunstler routinelyin case I need more of that. I myself am trapped in the 401koptions I am offered, which do not even include a treasury only. We dooffer some relatively low expense index funds though. Nevertheless,the world is what it is, and there is some benefit to plodding at leastpartially along in whatever game the system offers, becuause we are apack species and in fact do not really like going it alone aginst thetribe. Besides, when the s hits the f and martial law is declared, youwill be the first one they haul off - for the crime of being right! Bythe way, I posted this before January first on purpose so you couldreply in full without breaking your new years resolution. I personallyhope you break your vow. I will miss the vibe.
RE: Thanks, Justa, for that analysis.	lawabear	12/29/2007 9:30:29 AM
Company match are free moneies. Give it up is not wise.
RE: Thanks, Justa, for that analysis.	BLUE MAN	12/29/2007 1:06:34 PM
AsI have pointed out, the marginal rate is not what TPTB will do to getyou. It will be the penalty rate which will probably be 15-25% onexcess withdrawls. This will probably take you up into 60-70% range.Most people won't have to worry about this but the ones with accountsclosing in on $1million really do have a problem in the long run. Rasputin will probably be correct. Itseems like every end of year/beginning of year I see these comparisonsand yes if tax rates stay low it will be beneficial for tax deferral,but in these times with FEMA, the Patriot Act, a Democratic Congress,you have to assume that TPTB will ultimately try to reduce you topoverty.
RE: Food for thought on 401(k)s	gjohnsit	12/29/2007 10:36:30 AM
Thanks for doing the numbers. I agree that if a) the employer matches funds, and b) everythingremains pretty much the same (even with slightly higher tax rates),that the 401k makes sense. However, there is simply noprice you can put on having the ability to cash out your investment atany time. You can't put a dollar amount on the piece of mind that givesa person. You CAN put a dollar amount on that liquidity if thefinancial system freezes up, or the markets crash. I just don't think the pro-401k people properly value this flexibility. Sure, you can cash out your 401k if you quite your job (and who'sstupid enough to do that in middle of a financial meltdown?). You willstill take a 10% hit on top of taxes by doing that.
RE: Food for thought on 401(k)s	Mad Ludwig of Bearvaria	12/29/2007 11:58:24 AM
" Sure, you can cash out your 401k if you quite your job (and who'sstupid enough to do that in middle of a financial meltdown?). You willstill take a 10% hit on top of taxes by doing that. " No penaltyif you put the money into an IRA. Even if you want to or have to liveon the 401(k) money, by rolling it into an IRA, you can avoid having itall taxed in one year, where higher marginal tax rates and loss ofcredits and deductions that are subject to phase outs may make the taxhit worse. If instead of having a 401(k), your employer paid youless and used the difference to fund a traditional defined benefitretirement plan, you would likely get nothing or close to it whetherseparation from employment is involved or not, so don't feel too badabout the "lack of liquidity". If anyone puts too much money ina 401(k) and too little elsewhere where they can get at it if needed,it is not a defect of the 401(k) plan but of the planning ability ofthe employee who decided what to do with his savings. Many 401(k) plansallow for borrowing or withdrawing up to $50,000 or 1/2 the accountbalance for emergency purposes or hardship, so there is some access formany to 401(k) funds even without leaving a job.