The Home 
15
comments

Saving For A House: 401(k) vs. Brokerage Account

Email  Print Print  

This morning I did a bit of an apples to oranges comparison of a 401(k) and a high yield savings account, showing that the two would meet two years and two months out given a set of probably unreasonable assumptions. It was apples to oranges because the risk involved in investing in the stock market simply isn’t anywhere near the risk involved in saving money in a high yield savings account. So, I took Anne’s suggestion and compared a pre-tax account, in this case the 401(k) again, and a post-tax account.

Results? 401(k) never catches up. Despite starting with more money, $133 vs $100, 401(k) can never get over 25% the marginal tax rate + 10% penalty hit that it takes when you extract funds from it (not a loan, a straight up withdrawal). If you plan on pulling out your 401(k) funds to buy a house, don’t put them in there in the first place. Make the minimum contribution to get your match, then put the rest somewhere else.

Assumptions

  • Better is defined as the approach that ends up with the most amount of gain.
  • You are in the 25% marginal tax bracket.
  • Both accounts return 11% a year, or 0.8735% each month, compounded monthly.
  • There is no 401(k) contribution match by your employer. An employer match will bring in the breakeven point and raise the value of the 401(k).

Pretty Charts!

The chart below plots the growth of the brokerage account versus the 401(k) account. The value shown is the final extracted value, but growth is based on the non-extracted value. For example, with the 401(k), it’s the pre-tax dollar amount that is being compounded but the graph is showing that value reduced by 35% (25% tax, 10% penalty). The brokerage account line is growing based on its unrealized gains but the value shown is the realized gain, minus long term or short term capital gains. If you’ll notice the little hitch in the purple line at around month 12, that’s because the brokerage account tax rate fell from 25% (short term capital gains) to 15% (long term capital gains).

brokerage account vs 401k growth chart

If you’re interested in the Excel spreadsheet I played with to reach these simplistic conclusions, I’ve made them available here. Please check it out and let me know if you see any mistakes I may have made.

{ 15 comments, please add your thoughts now! }

Related Posts


RSS Subscribe Like this article? Get all the latest articles sent to your email for free every day. Enter your email address and click "Subscribe." Your email will only be used for this daily subscription and you can unsubscribe anytime.

15 Responses to “Saving For A House: 401(k) vs. Brokerage Account”

  1. Matthew Paulson says:

    I’m in the process of saving for a house, even though I have no intentions of buying for another 2 years when I’m out of graduate school, I’m using plain-jane certificates of deposit… It’s just too short of a period to mess with the market. I’d hate to not be able to buy a house because wall-street takes a dive.

  2. akb says:

    What about using a Roth IRA? You can take your contributions out at any time and you can take out $10K in earnings to buy a house, both tax and penalty free.

  3. Anne says:

    Very cool follow-up post. I do hope this convinces your friends not to go the 401(k) route, at the very least.

  4. jim says:

    Yeah, I don’t think they are going to but putting numbers really drives it home that this is a bad idea, thanks for the idea Anne.

  5. jb says:

    Good article, how does it change with a Roth IRA or Roth 401(k)?

    FYI your link to the spreadsheet is for the HYS comparison, not the brokerage comparison

  6. jim says:

    jb: Fixed it, thanks!

  7. Jay Muntz - valueaverager.com says:

    Whoa! It cannot be the case that 401(k) never catches up. I did a very similar analysis of this question on my blog only a week ago. My model (which is by no means perfect) shows that you would catch up after 26 years. Jim’s model shows that you catch up after about 21 years. I determined this on Jim’s spreadsheet by copying is formulas down a few hundred more rows and seeing where the 401(k) finally pulls ahead of the taxable, which is row 255.

    For the specific example of saving to buy a house, I guess there isn’t much difference between “never” and 21 years. However, stating that a 401(k) never catches up implies that a 401(k) plan would be useless for retirement planning. That’s usually (but not always) wrong.

  8. jim says:

    I looked at your spreadsheet and I didn’t see a 10% penalty (on top of the tax rate) for early withdrawal of your 401(k), did you take that into account?

  9. Jay Muntz - valueaverager.com says:

    You can change the tax rate at the top from 25% to 35% to include the penalty.

  10. jim says:

    Ah, I see where the difference is. You have the Taxable Rate of Return (ROR) at 6.8% instead of 8.0% because you’re taking out gains each year. In my comparison, I only take out the gains when you decide to sell. So while the numbers being compared are both after taxes, the growth of the Taxable Balance is based on the pre-capital gains tax value.

    If you make that change to your spreadsheet, it 401(k) never catches up.

  11. Jay Muntz - valueaverager.com says:

    Jim – I think the change you made revealed other errors I had made. Here’s an updated spreadsheet that I think is more accurate. I changed it to take out the capital gains tax when funds are withdrawn from the taxable (like your model). I also reduced the principle from $1000 to $750 in the taxable account to account for the fact that the IRS takes it’s cut before you deposit the funds in the taxable.

    The result is that the 401(k) makes sense after 21 years. This is now the same as what YOUR model says if you extend it out for that length of time.

    My original point was that a 401(k) always makes sense in the long run. This is obviously true, because if a 401k(k) never beat a taxable account, then why would anybody ever contribute to a 401(k) beyond the employer match?

  12. curious and math-less says:

    The angle I’m wondering might be missing is how the contribution to the 401(k) might make to your overall tax bruden. Assume, for example, that you max out your contribution at $15,500 a year, and that’s $15,500 that’s not taxed — and if you’re doing that, you’re probably in a high or highest tax bracket. If you start there and work backwards, does it make a difference? Because from what you’re saying, because I get no match from my employer in my 401(k), I shouldn’t participate in my 401(k) at all and just put all my money in my 5.00%… or 4.50 (keeps dropping) MMA. This would be especially true for someone like me that thinks the market will looks something more like 11,000 by February of next year rather than the 13,000 of today.

  13. Jay Muntz - valueaverager.com says:

    Don’t forget that the $15,500 will be taxed eventually; when you withdraw it.

    I believe that most people do better by participating in a 401(k) than a taxable. I believe that if you’re over 50, you *might* be better off directing any new savings to a taxable account, because of the issue of your cap-gains and dividends will be taxed as income when you take them out. If the money is going to stay in for more than seven years or so, you should put it in a 401(k). The models Jim and I are doing aren’t realistic enough to be used for planning your personal finances (in fact they are seriously flawed if you’re planning to use them that way).

    Also, I don’t believe you should try to predict where the market is going. Instead you should reduce your risk profile as you get older (i.e. gradually shift from stocks to bonds).

  14. curious and math-less says:

    … one more thing… I’m sitting here playing with the spreadsheet, and wondering why you’re assuming you’d close the 401(k). My 401(k) lets me borrow from it (as long as I pay back into it with interest.) I really just am not understanding this at all. From my perspective, this whole point of this post is just inaccurate. But I’m a math idiot, so I’m doubting myself. But at the same time, I don’t max out my 401(k) because I don’t trust the market. So I’m honestly interested in trying to get to the bottom of this.

  15. Jay Muntz - valueaverager.com says:

    I originally created the spreadsheet to support the point I made on my blog. I also thought it was useful for discussion of this post, which is why I chimed in here.

    The disclaimer that is in the post and the spreadsheet says: don’t use it for your own financial planning. It sounds like that is exactly what you’re trying to do. Please don’t do it.


Please Leave a Reply
Bargaineering Comment Policy


Previous Article: «
Next Article: »
Advertising Disclosure: Bargaineering may be compensated in exchange for featured placement of certain sponsored products and services, or your clicking on links posted on this website.
About | Contact Me | Privacy Policy/Your California Privacy Rights | Terms of Use | Press
Copyright © 2014 by www.Bargaineering.com. All rights reserved.