401k and Roth IRAs

[otc]

When will the loan be paid off otherwise? At 6%, I'd be inclined to stick to the current payment plan.

Odds are, the money will do better in a 401k. And the interest on that money will compound over a growing base (the interest on your loan is compounding over an ever shrinking base).

I understand the desire to get rid of the loan just to have it gone, but if you are still getting a tax credit for it and aren't paying too much interest, I'd be hesitant to change anything. Are you planning to go back to school at any point? I have loans that I could pay off in cash today, but I think they are all at 6% or less and I just don't think it is worth it...especially since I think they all go back into interest-free deferment if I decide to go into a part-time program.

 

[Ketawa]

Hypothetically if I can earn 5 to 6% on my company retirement account, would it be smart to continue my salary deferral for 2014 or pay off a loan in 1 year that has an interest rate peaking near 6%. I have been maxing out my IRS contribution limit this year while making payments to my student loan.

However, I realized that in a years time of contributing to the savings plan, I could have easily paid off my student loan.

I sort of want to take the burden off my shoulders if I can pay it off soon rather than later. The only upside to keeping the loan is a small tax deduction at year end, and hoping that my portfolio will perform well.

My plan is to pay off the student loan in 2014, open up a IRA in lieu of deferring to the company retirement plan, and start contributing again in 2015. I have not done the full math but I think this would also allow me a bit more flexibility in terms of disposable income. FWIW I claim "0" on my W-4.

Thoughts?

What is your marginal tax bracket? You need to determine the tax-adjusted interest rate of your loan to make a good decision. Paying off the loan is a guaranteed return of X%, while you can't earn 5-6% in the market without taking on risk.

If you max out your tax-advantaged space and plan to continue doing so in the future (always a good decision), then the value of that space available to you now is greater. If you didn't max it out, you could direct cash towards the loan, then catch up later in the tax-advantaged account. That isn't possible if you're maxing it out.

Another option is to use a 401k loan to pay off the loan, if you have that available to you. You preserve the valuable tax-advantaged space and it's likely that the interest rate is lower on a 401k loan.

 

[otc]

Ah yes, that's right (although you are more likely to be maxing out an IRA than a401k). Also applies if you are getting an employer match on your funds which is a guaranteed return much higher than 6%.

If the choice is between maxing out a yearly contribution and paying extra on the loan, the contribution (or employer match) is more important. You can always pay more on the loan next year, but you can't put extra money in the account (or get more employer match).

 

[gettoasty]

Good feedback. I need to create an Excel file

I get a 3% match at year-end, no loan option in the plan. For something like this I probably would not even consider loaning out from my 401(k) unless 50k makes a difference as a first-time home buyer.

The idea of having a loan is a bit infuriating. I can technically max out my company plan, and increase my loan repayment amount but then that also leaves little disposable income left.

I do want to go back to school/part-time program, and considering a mortgage, too. Hence, I do not want to juggle everything at once.

Nelnet does not provide some type of amortization table, may need to call them. But at my current rate I have already cut my loan period by more than half. If I continue with my current routine, I can still pay it all off in 3 to 4 years or less if I decide to dump in my tax return(s).

I am also not accounting for company pay raise etc.

Just more of a general thought whether losing out on 1 year would leave that big of a dent in my retirement portfolio. As I said, I would still be utilizing the IRA account as a cushion.

 

[mkarim]



You can always pay more on the loan next year, but you can't put extra money in the account (or get more employer match).

+1.

 

[JJeff]

A 401(k) and a Roth IRA both offer different advantages and disadvantages. If these are your primary retirement vehicles, it would probably be smart to invest in both and split your total investment. An IRA typically has a cap of how much you can invest each year. Focus on investing in your IRA until it is capped out. Then begin to shift more into your 401(k). The reality is that in a good market, a 401 will ultimately generate a larger return than an IRA. The advantages of an IRA, however, is the fact that you won't wake up one day and realize that half of your investment has suddenly vanished as can happen with a 401.

 

[Ketawa]

A 401(k) and a Roth IRA both offer different advantages and disadvantages. If these are your primary retirement vehicles, it would probably be smart to invest in both and split your total investment. An IRA typically has a cap of how much you can invest each year. Focus on investing in your IRA until it is capped out. Then begin to shift more into your 401(k). The reality is that in a good market, a 401 will ultimately generate a larger return than an IRA. The advantages of an IRA, however, is the fact that you won't wake up one day and realize that half of your investment has suddenly vanished as can happen with a 401.

Most of this is wrong.

 

[austinite]

Yeah, by its nature, an IRA allows you to take on whatever risk level you want (you pick the investments).

To start you always want to max anything your company matches. That is free money. After that I would focus on anything that is 100% tax free like an HSA. Then I would do the Roth IRA provided your income is in range. If you have anything left after that you can do a traditional IRA. I probably wouldn't put anything in the 401k beyond what gets matched.

 

[mkarim]



I probably wouldn't put anything in the 401k beyond what gets matched.

Why not? Granted, you are restricted to the mutual funds in the Plan, but its not a bad way to shield that money from taxes until you are ready to roll them into a Roth. If one doesn't like any of the stock mutual funds, one can put the money in a money market mutual fund in the Plan.

 

[otc]

You can't put money in a Roth and then into a traditional. The caps aren't separate.

So once the roth is maxed, your retirement dollars should go back into the 401k realm.

Generally (I'm sure I have written this on here before so sorry for the repeats) you want to go:

1. 401k to the max employer match.
2. IRA to cap (Roth or Trad depending on your situation).
3. 401k to the max.
4. Non-tax-sheltered accounts.

Of course, if you make it to #4, you either have a really high savings rate, or you are past the income range where a roth is an option...Presumably you are doing all of your short term savings in between #2 and #3 (emergency fund, down payment, travel, etc).

 

[mkarim]



You can't put money in a Roth and then into a traditional. The caps aren't separate.

So once the roth is maxed, your retirement dollars should go back into the 401k realm.

Generally (I'm sure I have written this on here before so sorry for the repeats) you want to go:

1. 401k to the max employer match.
2. IRA to cap (Roth or Trad depending on your situation).
3. 401k to the max.
4. Non-tax-sheltered accounts.

Of course, if you make it to #4, you either have a really high savings rate, or you are past the income range where a roth is an option...Presumably you are doing all of your short term savings in between #2 and #3 (emergency fund, down payment, travel, etc).

+100

 

[gettoasty]

Yeah I am changing it up this year. I am contributing enough and then some, but not by much in order to meet the ER match. Will then max out an IRA this year since I still qualify. A good portion of my take home pay will then payoff my student loan that I plan to pay it all in 2014. Remaining money is for spending and CE. As someone else mentioned I will go speak with my bank to see if I can open up sub-accounts that can automatically allocate per deposit to create further savings for various things like a home, travel/vacation, etc.

On the other hand, I am not sure if the IRA deduction will be that beneficial and believing that my tax bracket will increase in the future a Roth maybe a better idea. Might just do 50/50 this year.

 

[austinite]



You can't put money in a Roth and then into a traditional. The caps aren't separate.

So once the roth is maxed, your retirement dollars should go back into the 401k realm.

Generally (I'm sure I have written this on here before so sorry for the repeats) you want to go:

1. 401k to the max employer match.
2. IRA to cap (Roth or Trad depending on your situation).
3. 401k to the max.
4. Non-tax-sheltered accounts.

Of course, if you make it to #4, you either have a really high savings rate, or you are past the income range where a roth is an option...Presumably you are doing all of your short term savings in between #2 and #3 (emergency fund, down payment, travel, etc).

You are right, not sure what I was thinking there.

 

[jakeyt]

Does it make sense to do a 401K then convert it over to a Roth IRA? Can this be done at the end of every year or can the conversion only happen after you leave a company? I researched it a bit but this is not clear to me. If I have the limit of $17,500 in 2014, can I convert the entire thing?

One thought is that I'd like to buy a house. Rather than let that money sit in a different account doing nothing, I thought I could use whatever excess money to put into my Roth IRA and withdraw it (the principal) when I am ready to put down a deposit.

Thoughts?

 

[mkarim]



Does it make sense to do a 401K then convert it over to a Roth IRA? Can this be done at the end of every year or can the conversion only happen after you leave a company? I researched it a bit but this is not clear to me. If I have the limit of $17,500 in 2014, can I convert the entire thing?

One thought is that I'd like to buy a house. Rather than let that money sit in a different account doing nothing, I thought I could use whatever excess money to put into my Roth IRA and withdraw it (the principal) when I am ready to put down a deposit.

Thoughts?

The $17,500 is the annual limit is for contributing to your 401K. You can only rollover your 401K after you leave a company. The annuak limit to CONTRIBUTE to a Roth IRA is $5,500. However, when you leave a company you can rollover your entire 401K money into a Roth IRA as rollovers are not subjected to the $5,500 annual limit. However, if your 401K contributions were pre-tax, you'd have to pay taxes on rollover funds; if your 401K contributions were in Roth 401K format you won't have to pay taxes when you roll over, since you've already paid taxes on them.