Unthinkable: Should I Discontinue My Roth 401k Saving?

by Kevin on July 31, 2008

Before you freak out with “I can’t believe a personal finance blogger would say such a thing!”, let me explain.

I work at a large privately held corporation. In my opinion the 401k plan is severely lacking. The investment options are “okay”. I’ve got holdings setup like this: 65% in a Vanguard S&P 500 index, 16% in an international fund, 16% in a small cap fund, and 3% in bonds. The expense ratios are decent, but not great.

I do have to give the company a compliment because they implemented a Roth 401k program quickly after they became a legal option. I switched my investments over from the 401k (pre-tax) to Roth 401k (after tax) as quickly as I could.

It’s All About the Match

My main issue with the 401k plan is the company match. We’re a privately held company, but we’re not small. We’re massive. We make billions (literally) of dollars per year.

The company match is setup like this: 100% match for the first $500 invested, 50% match for the next $500 invested, $0 after that. If I put in $1,000 in a year, they will give me $750.

The match is absolutely terrible when compared to other companies that just do a straight up percentage match of what you put in. Some common ones I’ve seen are 100% up to 3%, 100% up to 5%, or 50% up to 6%. All of those options would be better than a measly $750 per year.

I’ve Already Hit the Match Ceiling

So this past pay period I went over the $1,000 threshold to get the full match at the beginning of next year. Now I’m weighing my options and we’re considering stopping the contributions to the retirement account. Generally speaking, that’s a terrible idea. A big issue for most people is inertia. It takes them six months to setup their 401k at work simply because it means looking at and filling out forms.

Risks of Stopping Your 401k:

  • If I end retirement contributions today, I would have to remember to reactivate them in the future. Being a personal finance blogger, I would most likely remember (and would setup a reminder system as well)… but it is still a risk.
  • The extra money that would come to my paycheck might be used for frivolous things. Let’s say I’m saving $100 per month in the Roth 401k. If I stop contributions, that’s a direct $100 I’ll have extra in each check. I’d rather be saving for retirement than buying things I don’t need with that money.
  • I might use the extra money wisely by integrating it into our budget. Even if I did remember to reactivate it next year, it might “hurt” us then because we are used to having that extra money.
  • I might miss out on depressed stock prices. The markets have been down this year. The idea is to buy low and sell high. Now might be a good time to continue buying low.
  • Again, consistency is king. Staying invested for the whole year, every year, is probably the safest option.

With all of those risks above why would I even begin to consider stopping the contributions? Find out tomorrow when I’ll explain what we’re going to do. Think you will forget to come back? Use the Subscribe to No Debt Plan subscribe button in the top right of every page to get e-mail and RSS updates sent directly to you!

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Ashley @ Wide Open Wallet July 31, 2008 at 11:12 am

Are you already maxing out your IRA? If so then I would stick with the crappy 401(k). If not then stop the 401(k) and use it to max out your IRA. Assuming the investments are better over there.

Kevin July 31, 2008 at 2:39 pm

@Ashley, yes we are maxing out our IRAs with monthly contributions. I do like our IRA investment better, but as you know it is capped every year.

Livingalmostlarge July 31, 2008 at 2:47 pm

Are you sure it’s even worth doing a Roth 401k? Why not a regular 401k? I’ve discussed this in depth on my blog and had a few posts about why it doesn’t make sense likely over $150k income for married and $100k single.

It really depends on where you live (state income taxes) and what you make.

Assuming a Roth is always better isn’t true.

Kevin July 31, 2008 at 2:55 pm

@Living Almost Large: My belief is taxes are bound to go up. Getting a tax break now is nice, but I’m counting on us being in a higher tax bracket when we get toward retirement age.

I’m more concerned with saving because at the end of the day you pay taxes on it — today or tomorrow, you pay taxes.

Livingalmostlarge July 31, 2008 at 3:19 pm

Here’s the deal if you are in the tax bracket of 28% or higher (When a Roth IRA phases out) it’s not necessarily true that you will be at that level in retirement. I’ve discussed this with multiple CPAs. As you hit 28% and higher, there is no guarantee you’ll be there.

What happens if we move to a flat rate tax 15% on everything? What happens if you decide in the future that you want to not work for 1 year and roll over your 401k to a Roth IRA? It might be taxed at 10 or 15% the year you aren’t working.

Don’t forget that 28% you are locked into paying at least that or 33% or 38%. Thus tax implications are important. Also when you retire, if you pull the majority of the money out one year and pull out $60k that would put you in the 15% bracket versus the current 28% bracket. So it realy depends on what you earn. There is a reason why people who phase out Roth IRAs don’t lobby to do it. Because they know they’ll be able to shelter their money in more than a Roth IRA.

Also it depends on where you live. Say you live in CA or NY, high state income taxes. Well why are you paying 12% in CA @ $150k income when you move to Florida, New Hampshire or even just anywhere with a lower state incom tax than those two places?

When you draw on it, and pay in MA 5% versus 12%? or 0% versus 12%? That’s a lot of income tax to make up. Plus you’ve cut your investment by 12% in the beginning.

I have a post showing that people in CA making above $80k are paying 12% income tax state. Probably next week. In that case you betcha i’m sheltering all income in a 401k.

Right now our 401k saves us about 30% – 33% on taxes. I’m not sure we’re going to be paying that much in the future. Between taxable accounts in the future if it sticks to 15% long term capital gains only, and Roth IRA, I am betting that we can beat that.

Warren Buffet only pays 15% federal income taxes because his money is from long term capital gains and dividends.

Funny about Money August 4, 2008 at 11:37 am

Tho’ a flat tax strikes me as real unlikely and it’s reasonable to expect taxes on long-term capital gains & dividends will rise, overall LivingAlmostLarge’s arguments make sense.

My tax lawyer remarked that it’s better to have your savings out of IRAs and 401k’s if at all possible. She does say that if your employer matches a 401k you should take it, but over the long run your heirs will get more of your estate and you will have far fewer hassles if your money is in nontax-deferred instruments. That’s wot she says, anyway….

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