Halls of Shrewd'm / US Policy❤
No. of Recommendations: 0
My son is 24 and an industrial operations engineer finishing his second year at a job where he makes close to $100K/year but can expect substantial pay increases in the next 5 years which could more than double his income.
His federal tax rate is 22% this year and possibly 24% in 2025, and his state tax rate is 5%
His employer matches the first $2150 in 401k contributions. The overall max my son can contribute to a 401K plan will be $23,500 in 2025.
I do not yet know the investment choices he has available in his company's 401K plan, but i assume it will be a few index funds, broad-type mutual funds and target retirement funds.
He has a taxable brokerage account(that I still manage with him). It was once an UTMA that became his at age 21. After using some of these funds for college, he still has over $500K in that account with a lot of unrealized long-term capital gains. My son's long-term capital gains tax rate is 15%.
He currently doesn't want to contribute more than the matching amount to his 401K because of cost of living expenses while making right about $100K per year. Note - He does max his annual Roth IRA contributions each year.
SOOooo - would it be wiser to max his 401K plan now, and pay himself that amount from his taxable account for the next 4-5 years, or just wait and plan to increase his annual 401K contributions as his salary increases? The former plan would represent about $6,670 not paid annually in state/federal taxes (until he retires), but he would be paying something less than $1000 in long-term capital gains each year.
I appreciate your thoughts - Smufty
No. of Recommendations: 4
Given your son's age and prospects, I think that shifting assets from taxable to tax deferred (the net effect of what you have described) will be the best move in the long run.
Taxes are always worth avoiding, assuming the tax deferred account can be managed in accord with your son's investment preferences.
Baltassar
No. of Recommendations: 1
One rule of thumb is to put 10% into retirement savings (spending the remaining 90%). Sounds like your son is close to that, and he's starting earlier than most people.
No. of Recommendations: 5
I always contributed the maximum allowed into my 401K, and now it's a very satisfactory source of retirement income.
Consider that the tax deferred by contributing to a retirement plan is at his top marginal tax rate. When the time comes to withdraw it, it will be at his average tax rate (assuming it will be his main source of income), which he can expect to be much lower.
But, diving into taxable savings that are subject to LTCG to make the retirement contribution, and paying 15% immediately, doesn't make much sense.
Elan
No. of Recommendations: 1
Thanks for the responses!
Sorry Manlobbi, I did not know a tax strategy board existed or I would have gone there first.
Smufty
No. of Recommendations: 3
When the time comes to withdraw it, it will be at his average tax rate (assuming it will be his main source of income), which he can expect to be much lower.
Maybe, maybe not. Considering that he has a strong savings program at age 24, he is likely to be a multimillionaire by the time he retires. 4% (which is about where RMDs start) of, say, $4 million is $160K. Plus, of course, he will have other income streams such as interest and dividends, annuities and Social Security.
DB2
No. of Recommendations: 1
My daughter who is just a few years older than your son is in a similar situation. The above tax treatment suggestions are solid. My suggestions, free advice is worth that, keeping it simple,
- contribute enough to the 401K to get the full match.
- those contributions should just go 100% into whatever the lowest-fee SPY-equivalent fund choice he has.
- if his company has a Roth 401K - switch to that.
- When you have a 401K, my understanding of the tax rules is you CAN'T contribute to an IRA (either a traditional or a Roth). From when I was released mid-year a few years ago. (Check with AJ485 on the "new" Fool discussion board or someone else in Tax Strategy).
- so the remainder of the 10% target total (or whatever he can save off) goes to his taxable brokerage account.
FC
No. of Recommendations: 7
When the time comes to withdraw it, it will be at his average tax rate (assuming it will be his main source of income), which he can expect to be much lower.
Maybe, maybe not. Considering that he has a strong savings program at age 24, he is likely to be a multimillionaire by the time he retires. 4% (which is about where RMDs start) of, say, $4 million is $160K. Plus, of course, he will have other income streams such as interest and dividends, annuities and Social Security.
True. But at today's tax rates, you pay no tax on the first $23,000 (on a joint return). You pay 12% on the next $70,000. And you pay 22% on the rest. So your average is about 15%.
Elan
No. of Recommendations: 2
Roth IRAs have some benefits (survive bankruptcy up to $1.5M, no taxes), but can't be contributed to above an income limit, and so are worth maxing out while you can. You can contribute to both a Roth IRA and a 401k.
"You can contribute to a Roth IRA (a type of individual retirement plan) and a 401(k) (a workplace retirement plan) at the same time. Anyone eligible can contribute to an employer's 401(k), but income limits apply to Roth IRAs."
https://www.fidelity.com/learning-center/smart-mon...
No. of Recommendations: 3
My son is 24 ... would it be wiser to max his 401K plan now..
Yes, absolutely, yes. Nothing beats tax deferred compounding in an S&P 500 ETF, especially when you're at that age.
1) Set up transfers from every paycheck (twice a month) to the 401K plan.
2) Set the amount to be transferred as $23,500 (max allowed in 2025) divided by the number of paychecks per year
3) Have that invested 100% in an S&P 500 index fund (like Vanguard Index 500 Trust). Every 401K plan has this option.
4) Don't touch that money.
5) Don't get cute and try to time the market.
6) Focus on his career, not the market. Get promotions and raises so he can add bigger amounts to that retirement index fund each year.
7) He can diversify to a stock/bond mix once he gets to his financial independence number
Happy Thanksgiving weekend to you and your family.
Mechinv
To succeed at investing, your emotional fortitude counts for way more than your IQ
No. of Recommendations: 1
Yes, absolutely, yes. Nothing beats tax deferred compounding in an S&P 500 ETF, especially when you're at that age.
I agree. However I do have some pause at the moment, as many folks are worried about the excessive concentration and high valuation.
One could also pick an SP500 equal weight, or split between the two.
For one of my daughters, I recommended RSP and a small cap growth index VBK.
Thinking about changing that to a mix of VOO, RSP, VBK, and the cap-weighted SP500 may continue to outperform for 10 more years, who knows.
It seems less and less folks have access to regular company sponsored 401K's these days.
Mark
No. of Recommendations: 1
The S&P500 has obviously been on a spectacular long term run and the most obvious simple way one should have invested. But there is a lot of evidence it has been too obvious and at this point is overdue for a correction. Maybe not any time soon but sooner or later.
One interesting argument for diversification not only from the S&P500 but to include other countries than the US which has also been on a run.
A European financial advisor on youtube for a different perspective:
Don't Invest in the S&P 500. Especially if you're retired. (108-year backtest results)
https://www.youtube.com/watch?v=eIUgjib_fm4
