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

By: Jay Muntz - valueaverager.com

Jay Muntz - valueaverager.com — Sat, 17 Nov 2007 01:33:49 +0000

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.

By: curious and math-less

curious and math-less — Sat, 17 Nov 2007 00:07:08 +0000

… 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.

By: Jay Muntz - valueaverager.com

Jay Muntz - valueaverager.com — Sat, 17 Nov 2007 00:02:17 +0000

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).

By: curious and math-less

curious and math-less — Fri, 16 Nov 2007 23:35:40 +0000

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.

By: Jay Muntz - valueaverager.com

Jay Muntz - valueaverager.com — Fri, 16 Nov 2007 23:20:46 +0000

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?

By: jim

jim — Fri, 16 Nov 2007 21:44:48 +0000

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.

By: Jay Muntz - valueaverager.com

Jay Muntz - valueaverager.com — Fri, 16 Nov 2007 20:20:11 +0000

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

By: jim

jim — Fri, 16 Nov 2007 20:16:27 +0000

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?

By: Jay Muntz - valueaverager.com

Jay Muntz - valueaverager.com — Fri, 16 Nov 2007 20:03:40 +0000

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.

By: jim

jim — Thu, 15 Nov 2007 18:03:10 +0000

jb: Fixed it, thanks!

By: jb

jb — Thu, 15 Nov 2007 17:35:42 +0000

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

By: jim

jim — Thu, 15 Nov 2007 00:18:15 +0000

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.

By: Anne

Anne — Wed, 14 Nov 2007 23:00:08 +0000

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

By: akb

akb — Wed, 14 Nov 2007 22:47:41 +0000

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.

By: Matthew Paulson

Matthew Paulson — Wed, 14 Nov 2007 20:29:16 +0000

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.