AskDong

I was very excited this past week to have made my first contribution to my Roth 401K.   At first I wasn’t sure if I wanted to dedicate all my contributions toward the Roth.   By contributing to the Roth 401K rather than a standard 401K, I’m effectively trading taxes tomorrow for taxes today.

I don’t have a view per se on what taxes will be for me when I retire versus what they are now.   Will taxes be higher?  Will I be in a higher income tax bracket?  Those are all questions that I cannot answer with any certainty.   However, the advantage of the Roth is exactly because of those uncertanties.

I compare the Roth 401K/Regular 401K debate to fixed rate mortgage versus an adjustable rate mortgage.  A fixed rate mortgage is not inherently better, but it gives price certainty.  That’s exactly what the Roth 401K does, it give me price certainty on what I pay in taxes.    

I max out what I contribute and as result I don’t have to make any tradeoff when it comes to how much I can contribute.   If anything because the amount I can contribute to either a Roth or Regular 401K is the same nominal amount (15,500),  I can effectively contribute more to the tax sheltered account as I pay in after tax dollars.  The one group of people who I think might be better off contributing to a standard 401K are those who cannot afford to contribute to get the full company match.  

Let’s say for example say I make $100, and my marginal tax rate is 25%, and my budget is $70.  I would be able to contribute $5 or 5% towards a Roth 401K.   Let’s also say my company matches the 1st 6% of my salary in terms of contribution.    By contributing to the Roth 401K, I would fail to max out my company match.   However if instead chose to contribute 6% towards a regular 401K, I would still be left with $71.25 in take home pay, and receive the full company match.

With the housing market in a bit of a slump and interest rates low, I thought it would be a good time to buy my first home. I am planning on buying a condo in the next few months.

My question is this — I know the IRS allows you to take out up to $10,000 from an IRA or a Roth IRA to finance a first-time home purchase. Do you have any thoughts on whether it would be better to take the money out of my Roth versus my Traditional IRA?

-s

Hmm, I would say it’s best to do neither. The IRS allows individuals to withdraw funds from the IRA penalty free, and in the case of the Roth IRA tax free (assuming the withdrawal is after 5 years). The withdrawal is considered a qualified distribution - not much different from taking distributions at retirement. Of course if you’re gains in the traditional non-deductible IRA are limited or non-existent, paying taxes may not come into play at all. Sound great, right? The fundamental problem with taking a distribution early even if it’s penalty and tax free is that you can’t put the money back in.

IRAs, and 401k are tax shelters.  By holding money in these vehicles, investors avoid the annual drag of taxes or in the case of the Roth IRA taxes on gains period.  Every year we only get a certain amount dollars we can shelter, and it’s use it or lose it proposition.  It’s not like we can not contribute one year, and contribute twice as much the next year.  For this reason, I think it’s critical especially when you’re young to get those dollars in, and maximize the amount of money you’re sheltering from taxes for the longest time possible.

I would say if you can look to other sources of funding. I would even suggest borrowing from your 401K.  At least in the case of your 401k, you’re actually putting the money back in.  As long as you’re comfortable with job security and or your ability to pay back the loan if you were to switch or lose your job, I think borrowing from the 401k can a good option especially if the payback period is over a short period.  Yes, you lose some period of tax sheltering, but if the loan period is short it shouldn’t be a big deal.  The criticism of paying taxes twice because you’re paying with after tax dollars is generally overstated since the initial loan is tax free and it’s the only the interest (that you pay to yourself) that is actually taxed twice.

Most Americans including myself assume that we’ll retire.  We think of retirement as natural stage of our lives, not too different from puberty. Everyone goes through it we assume.  The fact is retirement is a modern concept. Historically, and in most areas of the world people have worked up until the day they died.  Of course historically speaking, people have died fairly young. In Zambia the average life expectancy is a mere 37 years of age.  If I could only expect to live 37 year, I can’t imagine I would be thinking much about saving for retirement.

It’s well publicized that Americans are not saving enough for retirement. True enough if most Americans want to stop working and live off retirement savings, they don’t have enough. Over the last generation we’ve seen some reversal in the age old trend of the younger generation taking care of the older generation as an increasing number of younger Americans have become reliant on the largess of previous generation - they’re living at home to a greater degree in the least.  A bountiful retirement is and will be out of reach of many if not most Americans.

At the end of the day, however, I think as society we must accept that not everyone will be playing shufflepuck on 21 day cruises.  Retirement is in the end just another product to be consumed.  Just as I can’t afford a 60 foot luxury yacht, for many retirement is just another one of these luxury goods that they can’t afford.  Of course for some they have chosen or at least haphazardly chosen to consume other luxury good today instead of retirement later.

I came across this article on CNN on black police officers in Georgia were only getting percentage of what white police officers who had similar lengths of service. What I found incredulous is not that we are still feeling the impact of historic racism today, but that it wasn’t until 1976 that black officers became eligible for the pension plan enjoyed by white officers. I was born in 1976.

While I think wholeheartedly in this situation that the Government of Georgia owes these police officers something to make up for the discrimination that they were subject to, pensions are tricky. It’s not just retired black police officers, but old NFL players, and airline workers. The problem with most pensions is the disconnect from what they are and what they should be.

The traditional view of pensions and the prevailing attitude is that they are a guarantee to provide us for in our old age. There’s nothing wrong with this attitude and view. However this view as of late has begun to conflict with the reality of the pension system. Pensions are nothing more than a promise to fund us in our old age, funded by a big pot of money paid by both past contributions and current earnings on the part corporations. The problem is that many companies (think auto companies) are not going to meet those obligations going forward. The money they’ve set aside is too little, and the business too weak. Nobody 50 years ago thought that GM would be on the brink of collapse, but here we are now.

Starting with the introduction of the 401k (and 403B), individuals are much more responsible for planning their own retirement, and that’s a good thing. Indivual responsbility leads to greater transparency, and keeps companies from making ill advised promises. I believe there should be a safety net for retired and retiring workers, but that safety nest is probably best handled outside of the confines of any individual business. The global economy is too fickle and too fast to believe that companies will be able to keep promises that it makes today in 50 years. Some will and some won’t, and I rather not hand over my retirement to luck of the draw.

According to James Larue, he made a request to his 401k to sell in 2000 and his plan didn’t. Now he’s suing his employer for over $150,000 of losses in the tech bubble crash. While his suit in principle makes sense. James has a legitimate complaint if it’s true that he issued an order but the order was ignored. However when you start sniffing below the surface, the story begins to smell a little fishy.

James Larue worked at a management consultant firm and in 2000 and 2001 he says made requests to change his investment allocation that he says were not honored. However, he wasn’t aware of this until 10 months after the fact, and after a precipitous fall. Why wasn’t he aware? Was is he in coma? Was he on an undercover assignment? Nope, he just didn’t bother checking.

The administrators of his plan are potentially guilty one of two things. 1) they criminally defrauded Larue in some scheme to benefit themselves 2) they were sloppy and failed to execute the order. In the former case, they would need a reason to do this. There seems to be no apparent motive here for that. Both the employer and the plan administrator (companies like Fidelity and Vanguard) have no reason to prevent a transaction. They do not materially profit from not executing a request. It’s certainly possible that the plan administrator did not implement his request due to some type of clerical or technical error. However in that case, I’m unsure that LaRue would be due the full $150,000 for such an error. It’s not like he checked his account to make sure the transaction was processed. While I’m not a proponent of constantly checking your portfolio, I do think it’s important to check the portfolio and setup when you make changes.

I personally would not be surprised if LaRue either screwed up or there was some type of miscommunication. People are often confused between reallocating existing funds and changing where future investments are made. Maybe LaRue changed his future investments but did not change his current asset allocation? I find it hard to believe that someone who would bring this type of case all the way to Supreme Court is also the type of person who would wait 10 months before checking his account.  The Supreme Court is not hearing the case to determine liability as much if employees have the right to sue 401k operators under the laws that govern pensions. I can agree with Larue on that. I see no reason why a employee shouldn’t be able to sue a 401k operator if there is a real case of fraud. Larue’s case, however, doesn’t pass my sniff test.