Retirement Funds

I have two comments:

1) I didn't know Lindsay and Ray were econ majors! Cool! (Wait, are these the Lindsay and Ray from HS? If not, then I don't have any emotions either way.)

2) if your income doesn't get any better than it is now, this argument doesn't apply.

Holy crap, I hope my income gets better than it is now.

Yeah, I know, right? You and I are living at subsistence levels. Well, I guess I won't be soon. HAAHAA! : )

Yeah, Lindsay did econ and is now an analyst in Portland, and Ray did CS and Econ and is getting his masters/doing government work in San Diego.

Anyone with a graphing calculator or really cool software, work this out... would you please? :p

2 sets of equations. Compound annually for 40 years. On the first, put 2000 in a year. In the second put in 1600 a year (20% tax rate, too low for us but if it works out the way I think it should, the point will still be made). Now, at the end of 40 years, what is the total of the 1600 equation and what is 35% of the 2000 equation?

If you would be so kind, also run for 25 years.

That way we get the idea from 25-65 and from 25-50. If there is a benefit to paying tax now, it will likely only show up in 25 year equation (so if you're planning on retiring by 50 it might work out better).

Basically at a 20% tax you get an extra years worth of captial to compound every 5 years, in a 25% brack it's every 4 years. In a 33% bracket it's every 3 years. With compounding that adds up.

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But may, don't kid yourself too much, I'm not sure what the tax brackets are, but I think you're a lot closer to an upper level brackett than you think.

Ok Miah, FYI, you don't need a fancy graphing calculator to do this. I just hacked this out in excel in 30 seconds. (I'm giving 10% interest a year, because I don't know what else to use.)

20% tax on input of $2000/year, compounded annually, 40 years:
$778,962

25 years
$173,090

33% tax on input of $2000/year, compound annually, 40 years:
$642,644

same, but for 25 years:
$128,498

No tax on input of $2000/year, compound annually, 35% tax on taking out, 40 years:
$632,907

same, but 25 years:
$140,636

*****
Equations: ( (money_input*tax_rate) + (previous_year_total) )*1.1

My world is shaken ;p I found the equation in Excel (FV - Future value = function of[ Principal + constant addition + interest rate + number of years) and it was completely different from what I expected.

Your friends are correct.

I used 2000/1600 principal, 40 years, 8% return, 2000/1600 addition per year and here is what I found

(0% initial tax) 2000 @ 40 years = 561,562 - 1/3 = 376,246
(20% initial tax) 1600 @ 40 years = 449,249
(25% initial tax) 1500 @ 40 years = 421,171
(33% initial tax) 1340 @ 40 years = 376,246

25 years repeats comparative values (years are fewer though)

So if you have a constant tax rate it doesn't matter if you pay taxes upon entry or exit, but if you have a lower tax rate it is preferable to pay at the time of entry.

Boggles my mind, but the numbers are there.

Thanks for doing the research guys : )

The only question I have now is that if you only take out money once you're retired/not earning any money except from stocks/retirements accounts, what type of tax bracket that puts you in.

Federal Brackets for 2005
0-7,300 = 10% tax
7,300-29,700 = 15%
29,700-71,950 = 25%
71,950-150,150 = 28%

So I am moving tax brackets once I start my new job. I think I'll roll over my retirement plan to an IRA.

Depends on what you get out of your retirement. Assuming a 500,000 fund, you're looking 30,000 of interest. That would put you in the 25% bracket.

Of course inflation would fit into all of this. And If you put more than 2,000 in a year you're likely going to see a larger return. Figure 6% payout (so 60,000 in yearly interest for a 1,000,000 retirement fund).

A 1.2 million fund would return 72,000 a year in interest, which would put you in the 28% bracket.

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I don't think I'm going to hit the 72,000 mark anytime soon, however you might May (Living in Cali and working for Intel). I'd ask the HR at Intel how long it would take to make it to a 28% bracket salary. You might be in a position that it doesn't matter which way you go. ;p

So if you have a constant tax rate it doesn't matter if you pay taxes upon entry or exit, but if you have a lower tax rate it is preferable to pay at the time of entry.

This makes sense, because if you are taxed upon taking money out, then you are taxed on the interest you earned too. So if you earn more money in interest than you would have lost from taxes on input, then more of your money is being taxed (thus a larger amount of money is lost).

Very true, I forgot to account for that. Providence matched a small percentage, though Intel doesn't.

The econ argument is that you should put in as much to your 401k to get the maximum match from your employer(free money), and then put the rest(post-tax) in stocks/mutual funds/IRA depending on your financial needs("low" tax bracket). Another thing to keep in mind is that eventually if you want to buy a house you'll need to have semi-liquid assets for that (not tied up in a retirement fund). Lindsay/Ray bitchslapped me because I was putting 75% of my income into my 401k and keeping none of it for savings. That and my bank account kept getting lower and I couldn't figure out why : )

The limit on a Roth IRA is 4,000 this year, and 5,000 the next. 401k's are definitely good, but I think having a distribution of 401k/Roth IRA is better. There's no arguing the benefits of compounded interest--but we're still trying to figure if tax before compounding is better than tax after compounding. (I'm no longer rolling over my 401k to my IRA...there's a 10% penalty for taking "benefits" from a retirement plan before you're 59.5. Instead I'll roll it over to the Intel 401k.)

But I was wrong before ;)

I'm not sure it makes sense to have both a 401(k) and a Roth IRA, as both are retirement funds (if I'm not mistaken). Why have 2 seperate funds when you can put them together and create a larger principle?

I would think it would make more sense to replace your Roth IRA with a mutual fund/stock collection. This would give you a more liquid form of investment to satisfy lump sum cash needs as life goes on. But would not dilute your retirement fund.

Dear lord woman, 75% in your 401k?!? Then I agree with Lindsey and Ray on that one. Putting money into a regular savings account is definitely very important. Xerox has a 6% matching and I've been putting 15%-17% in of my own. Enough that I'm putting a decent amount in every year, but not so much that I don't have any leftover to live my life (and pay off my school loans this century, cover rent, buy food...). Money for playtime is important, otherwise you won't make it to 65!

May knows what's up. She was probably trying to get as much into her retirement fund as she could afford in an effort to retire young. That is totally my plan too. Plus, she was living at home and so didn't have many (any) of the expenses you were talking about (rent, food, etc...). So I applaud May for her idea.

I agree that putting more in now is better, but retirement isn't the only thing on our plates right now. For example, saving enough for a down payment on a house is also a good investment. You aren't doing yourself any favors by putting everything into your retirement fund and then paying rent for the next 40 years because you can't buy a house. Paying taxes when you are single and don't own anything is the financial equivalent of bending over and taking it, well, you know...
I think there has to be a balance between the extreme future, the close future and the now. With general expenses (school loans, car costs, rent, food, yadda, yadda) and saving for large purchases (i.e. a house), there is a limit to how much is left for retirement. I'm perhaps in a different situation because I have large school loan payments every month, had to buy a car my first year of work(it was used of course, but still cost money to buy and then insure and maintain) and I graduated flat broke. By the time I started working I had $36 in my wallet and owed my parents $800 (living overseas with no work visa really nailed me). So if you already have a large chunck of change in savings, then I can see how it'd be possible to put a large % in a retirement fund.
But I still think that putting so much in that you are having to draw from a savings account to cover daily expenses is extreme.

Pumping a retirement fund early when you have limited expenses is a very effective use of your money.

Additionally, not everyone is looking to purchase a house in the immediate future, in a city like SF, renting might even be pereferable.

Additionally, for first time home buyers there are a number of government programs that help offset the downpayment hurdle. If you can afford it, I say pump your retirement fund before you have kids. You sure as hell can't when they come around.

No doubt. Honestly the 75% was pretty stupid on my part, but I didn't know any better at that point. I'm definitely more balanced now...I put in 10% in the 401k and have been saving up money that conveniently will now be used as for entry into the renting market costs. I just think it's nice that we can discuss things like this and work it out on our own without paying a financial advisor.

Also, I do think that (if you can split your savings) having two retirement accounts gives you a measure of balance between what we were talking about: pre/post tax money. Invest in the 401k up to the employer match, but after that I think the numbers are there that after-tax money ends up accumulating more, assuming certain starting/ending tax brackets.