Maintaining PP vs Tax Deferral: Which is more important

[arjking]

As a younger investor early in the accumulation phase, I cannot yet afford to max out my 401k/Roth contributions.  I need a Roth for TLT/GLD.  But max Roth contributions are 5k vs 16k with 401k.  So at some point in order to maintain the PP allocation I will have to decide to buy GLD in a taxable account instead of contributing more to my 401k.  Do I maintain the PP allocation in a taxable account with money that I could have contributed to my 401k.  Is the tax deferred treatment worth going overweight in stocks/cash?

[MediumTex]

Over the course of a career, people typically change jobs a few times.  Each job change allows 401(k) money to become IRA money, which is PP friendly.

Also, many 401(k) plans offer brokerage windows which are PP friendly.

Finally, a 401(k) plan loan can even be used creatively to facilitate a PP allocation.

Just think about your overall situation and you will probably see some opportunities.

[AdamA]

Finally, a 401(k) plan loan can even be used creatively to facilitate a PP allocation.

This is a good option to look into, and one that many people are not aware of.

[dualstow]

For what it's worth, my long bond allocation takes up my entire 401(k) and Roth.

This is because
- my retirement accounts were only set up a few years ago.
- I've held stocks for years and years, in taxable of course.
- If I squeezed everything into retirement accounts, I wouldn't have much of pp.

The good news is that you don't have to rebalance very often.
Yes, the tax hit on dividends can be nasty if you hold bonds in taxable. At least they are state tax exempt.
I truly think maintaining the pp is more important than having a perfectly optimized tax strategy. At the same time, since you're young, you'll have plenty of time to build up your tax-deferred accounts. I didn't even discover the pp until I turned 40.

[TripleB]

I believe tax optimization is far more important than maintaining the PP, especially for an investor under 40.

The government is in huge debt, and inflation is likely to be a big problem in the future, as well as rising taxes. The problem with inflation, taxes, and taxable accounts, is that the more inflation there is, the more you lose to taxes, and the less inflation-adjusted return you get.

Also, since taxes are expected to be significantly higher in the future, the more money you can squeeze into 401ks now, the better off you will be in the future.

There has been talks of dissolving 401k plans at the congressional level, but if this occurs, you will likely be grandfathered in whatever you currently have.

You can only put so much into 401ks each year, and once it's gone, it's gone, and you lose that potential tax-sheltered space forever.

401ks are protected from creditors.

Because you are contributing pre-tax money, you can contribute more to savings, than you could if you had to pay taxes now. As noted in my next point, you may *never* have to pay income tax on the 401k money if you plan things correctly.

You can perform 401k to Roth IRA conversions during low-tax years, such as if you retire "early" and live off taxable savings; you have no significant income, so you can convert portions of the 401k to a Roth, and pay zero tax, at least to your standard deduction/personal exemption.

If you live in a state with income tax, then you can avoid state income tax with the 401k, and potentially live in a state-tax free location in retirement.

If you go to eventually graduate school full time, your income will be zero and you will have huge tuition tax credits, plus your standard deduction/personal exemption that will let you convert about $30k of 401k into Roth IRA, tax-free, per year of grad school.

Contributing to the 401k reduces your AGI, making you more likely to qualify for the Savers Credit, Student Loan Interest Deduction, EIC, and other credits that are based on AGI.

I prefer the PP to any other type of investment portfolio, however if for some reason, due to limited 401k fund access, you find it impossible to maintain the proper PP, I would just do as much in the PP as possible, and then create a VP of the rest, and invest in stock index funds, or a balanced index fund.

401ks are "overpowered" (to use MMORPG terminology) and you would be foolish to not max it out, except in very limited circumstances.

[arjking]

Thank you all for the advices.  I am currently in graduate school full-time and working full-time.  The tuition deduction is not that much (about 4,000 max).  I am a federal employee so chances are higher than normal that I do not switch jobs and do not have the opportunity to roll-over my 401k.  (That's a whole seperate topic for another time.)  I have not yet considered rolling anything over into a Roth up until now because I'm still in a relatively high tax bracket.  I tend to agree with TripleB that the tax advantage is too good to pass up.  I had not yet considered that the 401k laws may be nixed entirely in the not too distant future.  Definitely a possibility worth considering.  In that scenario it's probably also likely I'll be out of a job!

[TripleB]

Are you a federal employee with TSP access?

If so, use the G-Fund for all your "cash" in the PP, and use the C fund for the stock portion. That's 50% of your PP right there. Then 25% can be in gold coins outside of the PP. That only leaves the 25% Long Term Bonds portion to be held externally in taxable accounts.

If your problem is that by maxing out the TSP you don't have enough left over externally for bonds/gold, then my solution would be to do a bogleheads type portfolio within the TSP until you have enough external assets to create a PP with it.

Personally, i'd love to have TSP access for PP use, because the C fund has a ridiculously low expense ratio for an index fund (0.025% compared to Vanguards 0.09%), and the G-fund is a tax payer subsidized MMF. I believe it's yielding about 2.5% today, in a treasury-guaranteed fund that is guaranteed $1 stable NAV per share, and you can liquidate at any time to rebalance from. That's friggin ridiculous.

I don't think you'd be "bad" to do a 70/30 or 60/40 split between C and G fund for a while until you have enough money to put in PP externally.

In fact, if I had the option to put all my money into TSP, but it meant I had to get away from the PP, I would do it, and do a 60/40 C/G split (with a little of the I - international fund in the 60% equity portion. The G-fund is just too good to pass up. It's literally free money, at the expense of tax payers.

[KevinW]

I prefer the PP to any other type of investment portfolio, however if for some reason, due to limited 401k fund access, you find it impossible to maintain the proper PP, I would just do as much in the PP as possible, and then create a VP of the rest, and invest in stock index funds, or a balanced index fund.

+1

My general suggestion:
1) max out deferral options
2) build the largest PP possible
3) if there is deferred space left over which can't be used as part of a PP, consider those funds a VP and invest them conservatively using whatever options are available

As MediumTex pointed out you will probably have an opportunity to rollover the 401k into a PP-friendly IRA.  And your employer may add PP-friendly options in the future.  Which is why I think the VP should be allocated conservatively; those funds should be ready to merge into a PP without locking in losses.

[arjking]

The G-fund is just too good to pass up. It's literally free money, at the expense of tax payers.

Yes I do have access to the TSP.  I hadn't realized what a good deal the G-fund was.

From the prospectus:
"The G Fund offers the opportunity to earn rates of interest similar to
those of long-term Government securities but without any risk of loss
of principal and very little volatility of earnings."

The thing is I kind of like to keep cash in a taxable account so I have access to it.  I consider that cash as part of my emergency fund.  It comes in handy when paying tuition.

Here is my current allocation:

Roth IRA: 25% GLD 25% TLT
Old 401k: 15% Stock
TSP: 10% Stock
Taxable: 25% cash

If I start maxing out my 401k I will very soon be overweight in stocks, so I will have to put a portion of it in the G-fund to avoid that.  In addition, I was recently married and now I have my wife's allocation to consider as I would like for us to be PP-allocated as a couple.  She currenlty has never made a Roth contribution.  Her 401k I think is in Oakmark funds (today is her first day of work so I'm not sure yet).  If GLD keeps going up, that would certainly help me maintain my allocation but I plan to use the Roth for TLT, then GLD in that order.  The rest I guess I'll have to improvise like everybody else.  Thanks for the suggestions.

[KevinW]

Can you rollover your Old 401k into a brokerage IRA?  That will give you more flexibility.

[arjking]

Can you rollover your Old 401k into a brokerage IRA?  That will give you more flexibility.

Yes I can, and that will help a bit.  But that's a one-shot deal.

[dualstow]

I just want to add that after reading tripleB's response, I realized that I focused on your title and missed the part about possibly contributing less than the max to retirement accounts. Gosh, the idea is so foreign to me that I glossed right over it. That is, I thought you were just talking about how you would meet your allocations with some capital in retirement accounts and some in taxable.

I'm truly sorry about not reading carefully, and I do agree with TripleB about contributing what you can to retirement accounts. I certainly max mine out, and if I couldn't afford to, I wouldn't be buying GLD in taxable. I suppose I'd be using the cash for necessities. That would be my only excuse for not contributing the max.

I've got a 67-year old friend who worked for the government for 20-odd years, btw, and he sings the praises of his TSP every time I see him.

[AdamA]

The G-fund is just too good to pass up. It's literally free money, at the expense of tax payers.

I use the G-fund for the majority of my cash, and I had no idea about the little "trick" they use to juice the returns.

Thanks for pointing it out.  Last year's yield was 2.81%, which is pretty good, given most Treasury-only money market funds
yield nothing right now.  Good way to boost the PP's performance a bit. 

[TripleB]

The G-fund is just too good to pass up. It's literally free money, at the expense of tax payers.

I use the G-fund for the majority of my cash, and I had no idea about the little "trick" they use to juice the returns.

Thanks for pointing it out.  Last year's yield was 2.81%, which is pretty good, given most Treasury-only money market funds
yield nothing right now.  Good way to boost the PP's performance a bit. 

Pretty Good?  :

How can you compare 2.81% with a Treasury MMF's 0.1%, for the identical level of risk and liquidity as being "pretty good"? It's incredible.

That's around an extra 0.6% return annually on a 4x25 PP, just due to getting extra yield off the cash portion. People on Bogleheads freak out to get a 0.1% savings in ER. 0.6% is huge, especially considered it's risk-free.

[TripleB]

Here is my current allocation:

Roth IRA: 25% GLD 25% TLT
Old 401k: 15% Stock
TSP: 10% Stock
Taxable: 25% cash

As stated above, just do a 401k to Rollover IRA movement from your old 401k to whatever custodian is holding your Roth IRA. You can rollover the old 401k into a Traditional IRA, but the Rollover IRA is marginally superior for no extra work. (Essentially a Rollover IRA is treated the same as a Traditional IRA for tax purposes except you retain the ability to re-rollover a Rollover IRA back into a new 401k at a later date, whereas you are unable to rollover a Traditional IRA into a 401k. You may never want to do this anyway, but there's no effort involved so just rollover the 401k into a "Rollover IRA")

Max out your TSP. As stated previously in my post, considering TSP has both the "best" cash fund you can get for the PP, and probably the best Stock fund as well, you can have up to half of your money in TSP and still have a perfect 4x25 HBPP.

A little side trick for you, that I've described in the past. Put your taxable savings into stocks, and slightly adjust your TSP to hold more of the G-Cash Fund to compensate and still hold 4x25. Then if you need money in an emergency, sell your taxable stocks, pay preferred long-term capital gains taxes on them, and within the TSP, trade an equal amount of G-Cash Fund into Stocks. The net effect is that you hold the same stock allocation as before, but were able to get preferred taxes. Also, you were able to get artificially higher G-fund return over what you could get in your taxable savings account.

Since stocks could drop 50%, I would suggest this method only if you have 2x what you need for an emergency fund, in taxable, so in the event of a 50% stock drop, you at least still have enough money in taxable stocks to sell (and you get to realize a nice tax-loss as well, while maintaining constant market exposure due to transferring G-fund to stocks within the TSP at the same time).

I'm envious of your TSP access and feel you have a greater HBPP option that most others without TSP access.

[arjking]

Max out your TSP. As stated previously in my post, considering TSP has both the "best" cash fund you can get for the PP, and probably the best Stock fund as well, you can have up to half of your money in TSP and still have a perfect 4x25 HBPP.

I'm envious of your TSP access and feel you have a greater HBPP option that most others without TSP access.

No doubt the TSP is a great vehicle, but if I max out my TSP, $16,500 annual, my IRA $5,000 (Which I don't think I can afford to do.)  I'd need another $11,500 to invest in taxable gold to maintain the PP (which I wouldn't have).  This was the crux of the original post.

[AdamA]

I would just not max out the tax free accounts.  You could also try 20% 20% 30% 30%.

[TripleB]

No doubt the TSP is a great vehicle, but if I max out my TSP, $16,500 annual, my IRA $5,000 (Which I don't think I can afford to do.)  I'd need another $11,500 to invest in taxable gold to maintain the PP (which I wouldn't have).  This was the crux of the original post.

Why can't you buy gold within the IRA using an ETF?

[HB Reader]

Max out your TSP. As stated previously in my post, considering TSP has both the "best" cash fund you can get for the PP, and probably the best Stock fund as well, you can have up to half of your money in TSP and still have a perfect 4x25 HBPP.

I'm envious of your TSP access and feel you have a greater HBPP option that most others without TSP access.

No doubt the TSP is a great vehicle, but if I max out my TSP, $16,500 annual, my IRA $5,000 (Which I don't think I can afford to do.)  I'd need another $11,500 to invest in taxable gold to maintain the PP (which I wouldn't have).  This was the crux of the original post.

As a former federal employee, I also had to perform a similar balancing act for many years.  I never found a perfect solution, but I realized then (and now) it was pretty good problem to have.  The "G" and "C" Funds are both very good vehicles.  

I would definitely contribute enough to get the government contribution match in your TSP, but then consider making some contributions to an IRA of some kind so that you could make investments in LLTs and gold.  As Adam1226 suggested, you might also consider slightly altering the PP allocations (e.g., 20/20/30/30).  Obviously, from a retirement/investment perspective the best solution is to tighten your spending belt and save as much as you can both inside and outside retirement accounts.  

BTW, when they converted from the old Civil Service Retirement System (CSRS) to the Federal Employee Retirement System (FERS) in the 1980's many federal employees were skeptical of the new system because they liked the more generous old CSRS pensions.  They thought they were being short-changed by Congress to save money.  I was absolutely elated to have access to a fund (the G Fund) that gave me Treasury Bond returns with Treasury Bill risk and switched to the new system as soon as I could.

But just to show you how fickle the investment markets can be, most investors (whether federal or private sector employees) during those years considered such fixed income returns to be pretty ho-hum.  They KNEW the real action was in the stock market.        

   

[arjking]

I can invest in ETFs in my IRA, but the IRA contribution limits are 1/3 of the 401k limits, so I guess most of my savings will be in the TSP going forward if I were to max out both.  I was considering using 2x leveraged ETFs in the IRA to maintain effective 25% exposure to TLT and GLD with just half the money. (Does that work out?)  I could balance that by going overweight in the G-fund and earning a decent interest rate in the process.  It may be risky because my IRA balance could go down very quickly and make my problem worse, but it is tempting.  I see using the 2x leveraged ETFs as borrowing money at 0-interest and investing that money in the G-fund and earning 2.8%.

[TripleB]

I can invest in ETFs in my IRA, but the IRA contribution limits are 1/3 of the 401k limits, so I guess most of my savings will be in the TSP going forward if I were to max out both.  I was considering using 2x leveraged ETFs in the IRA to maintain effective 25% exposure to TLT and GLD with just half the money. (Does that work out?)  I could balance that by going overweight in the G-fund and earning a decent interest rate in the process.  It may be risky because my IRA balance could go down very quickly and make my problem worse, but it is tempting.  I see using the 2x leveraged ETFs as borrowing money at 0-interest and investing that money in the G-fund and earning 2.8%.

Don't use 2x leveraged ETFs. You are not borrowing money at 0% interest. It's not a vehicle that guarantees you are tracking the index. Many people don't believe ETFs that hold Gold actually hold the gold. So in the event of a crisis, that ETF will vaporize. Imagine holding a 2x leveraged Gold ETF and there is a crisis. There's no underlying gold. Not to mention the fact that the ETF is guaranteed to slowly drop to 0 over time due to the mechanism of how the instrument is structured.

[Jimbo]

*  When using 401k remember that included in the statement $$total is the debt you have to payback to the government on withdrawal.  To understand this read this Canadian page.    When you see RRSP think 401k - they work the same way.  TFSA = Roth

*  That means-  when considering allocation weightings, you must measure the assets at their (after-withdrawal-tax value) not the grossed up value.

* Choose with asset to hold in which type of account according to the section on that same linked page.

[TripleB]

*  When using 401k remember that included in the statement $$total is the debt you have to payback to the government on withdrawal.

Not necessarily. I plan to never pay anything on 401k withdrawals through strategic withdrawals and Roth IRA Conversions to max out all available tax deductions while retired.

[Jimbo]

Doesn't change anything.  In your case you have decided your tax rate is zero.  So your after-tax value is the same as the before-tax value.