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Are Roth 401(k)s and Roth TSPs Better? (Part 1)

August 22, 2014 by Lazy Man 11 Comments

On page 37 of this month’s Money Magazine, Penelope Wang makes a strong suggestion that everyone should stop passing up on Roth 401Ks because they are better than traditional 401Ks. This was shocking news to me. I figured that if this is true, it should be “Front Page” material, not a buried in a one-page article with an extremely vague title: “Stop Passing Up This Great Deal.”

When I was writing this article originally, it wasn’t available online. Thus my research was limited to a spirited debate of it in the Boglehead forums. However, in the spirit of doing a little true journalism and receiving a lot of serendipity, I delayed the article a couple weeks. The delay means that a version of this article is now online (not the exact article, but very much the gist of it), sporting a more descriptive title of: “The Great Retirement Account You’re Not Using.”

Before I get into the article itself, I want to kick things off with my view of 401(k)s and Roth 401ks and explain why I believe one would choose one vs. the other. Spoiler: The biggest difference between the two is when you pay your taxes. The traditional 401(k) uses pretax money and is taxed when withdrawn. The Roth 401k uses post-tax money, but is not taxed when withdrawn.

Let me give you an example. Let’s say that I make $100,000 and I want to save 10% of that ($10,000) in some kind of 401(k) vehicle. Let’s say that I’m in a 25% tax bracket (I’m trying to keep the numbers simple.) If I pick the Roth 401(k), that $10,000 gets taxed, leaving me $7,500 in the account. If it grows 10% a year for 20 years, I’ll have $50,456 to withdraw tax-free. If I pick the traditional 401(k), that $10,000 goes in the account. If it grows 10% a year for 20 years, I’ll have $67,275 which will be taxed at withdrawal. After paying the same 25% in taxes, I have… $50,456 in spendable money.

So in this example, it doesn’t matter which one you do. They come out the same. The reason why someone would choose one over the other is the tax rate. If you are in low tax bracket and expect to be a higher one in the future, you want to pay those taxes now and get them out of the way. If you are in a high tax bracket now and expect to be in a lower on in the future, you want to pay those later at the lower tax rate.

Imagine my confusion when reading an article that seems to claim that the Roth 401k is almost always better. Penelope Wang says:

“Every dollar you save in a Roth 401(k) is worth more than a dollar you put in a pretax account. That’s because you’ll eventually pay income taxes on those pretax dollars while you get to keep every penny in a Roth. Granted, you get an upfront tax break by saving in a traditional 401(k), and you can invest that savings.”

Essentially she’s comparing a post-tax Roth 401(k) dollar with a pretax 401(k) dollar. It simply doesn’t make sense to do that kind of comparison. If you look at a Roth dollar without understanding that you’ve already paid tax on it, it is going to appear that you escaped the tax system altogether, which is simply untrue. If you downplay the upfront tax break by the traditional 401(k), you are missing the whole benefit of that 401(k).

In the aforementioned Bogleheads discussion on the topic, readers have found what appears to be the T. Rowe Price’s research.

Much of the Money Magazine article seems to say that the Roth 401(k) is better than the traditional 401(k) because of that T. Rowe Price research. I find that a less than satisfying explanation. I’d rather read exactly what the benefits are in terms of the applicable tax law.

It was at this point where the serendipity kicked in. I got an email about with all the people going to Fincon this year and spotted T. Rowe Price‘s Stuart Ritter, the person credited for the research. After some phone tag, we connected and I got a much more satisfying explanation. I hate to create a cliff-hanger (just kidding, I love it!), but that explanation is worthy of its own article, so tune in tomorrow.

I want to leave by saying that I’ve probably been too harsh on Ms. Wang. Often, editors create the titles in magazines, so the lack of descriptive was not likely her doing. In addition, writing words online is cheap and easy. I don’t have specific space requirements like print magazine writers do. I can afford to give a much more detailed explanation in an entirely separate article. I don’t think anyone could have done the topic justice in the space provided. It’s a shame it wasn’t a two or three page feature.

Filed Under: Investing, Retirement Tagged With: 401k, money magazine, T. Rowe Price, TSP

Marriage Tension and Money

April 9, 2014 by Lazy Man Leave a Comment

This month’s Money Magazine had an interesting article asking What’s Your Money State of Mind? The article is the result of a survey of 1018 Americans who are 18 or older. The information in the magazine is presented better than the article on the web. It gave more statistics and fewer anecdotal quotes. Regular readers know that I’m more of a statistic guy… anecdotal quotes can be used to show almost anything, even alien abductions.

One particular graphic caught my attention. You’ll want to want to click on it for a bigger version that will open up in a new window.

As the graphic reads at the top money is the top source of marital tension. It is both the most frequently argued topic and the source of the most serious arguments.

I would have loved if they could have dug a little deeper on the questions considering it is Money Magazine. It’s great to know that Quality Time Together is 30%, but give me more details on the money aspect. What percentage of the arguments are about the lack of money. I’m guessing some 90%, right? What percentage is about good money problems, such as fights about using extra money to buy stock in IBM vs. Lululemon. That’s got to be a minority of the arguments, right?

I’m just curious to know those numbers so I don’t make too much of a false assumption here that the tension is from a lack of money. Nonetheless, given the recent news about the Americans being unprepared financially, I’m going to go out on a limb and make that assumption. I do that recognizing that lottery winners have their share of money headaches too, it’s just of a different variety.

There’s an old saying that money can’t buy happiness. However, it seems like it can prevent 41% of marital arguments. If that isn’t reason enough to take charge of your personal finances, I don’t know what is.

Actually, I take that back. I’ll give you a few more reasons… the rest of the graphic. If you look at the items almost all of them tie into money.

Household chores are the second most frequent and most serious arguments. We got a cleaning service to take care of much of that every couple of weeks. We still have plenty of chores, but they are much more manageable and very few arguments about them. It is one of our best uses of money.

Quality time together was also cited. The old saying that time is money is apt here. The converse is also true, money is time. Using the example above of hiring a cleaning service, money has bought us time. Hiring a landscaping company can buy time. Hiring a babysitter also buys time. What you do with that time is up to you.

I’m going to skip over raising kids, because I feel that isn’t mostly money issue, but more of a parenting strategy one.

Finally there’s the question of what’s for dinner. Money obviously can solve that by going to a restaurant or hiring a chef to prepare frozen dinners for a week or two.

There’s a lot more to marriage than money, but money plays a big role. It’s too bad it got put in a small graphic at the bottom of the page. Oh and you are on your own with snoring. Good luck.

Filed Under: Couples and Money Tagged With: marriage, money magazine

Does Materialism Breed Unhappiness?

March 27, 2009 by Lazy Man 10 Comments

Below is a guest post from LAL from LivingAlmostLarge and LAL Musings. I’ll let her introduce herself: “I’m a twenty-something DINK, living in the northeast searching for financial freedom. I hope to one day live large and be financially free, but it’ll only happen one step at a time. I admit to not being the most frugal or smartest financial blogger, but I think I’m giving a real perspective on the challenges faced by many other young adults. So please stop on by. I have a couple of giveaways going on including a 1 year subscription to Money Magazine if you subscribe to my RSS or Email feeds.”

This week I read this post called “Materialism breeds unhappiness, ” by Embrace Living. The writer suggests that as a society we use material possessions to value ourselves. Thus it breeds discontent and unhappiness because we are constantly wanting the newest fashions, etc.

She says that there is something within that is wrong with you that causes you to want material possessions. That we have to investigate what it is, work on it, and become happier. I guess she’s preaching the idiom “Money can’t buy happiness.”

Honestly do I think that? Well let me say this, money can’t buy happiness, but it can certainly make you feel better. And anyone who says money can’t buy happiness hasn’t been poor. I am not knocking this chick, I don’t even read her blog. But BTDT [Editor’s note: is it a sign that I’m old that it took me three minutes to realize that this is “been there, done that”?] about being poor and HELL NO I’m not going back.

I believe money buys me freedom and peace of mind. It allows me the freedom to choose where I live, how I live, and what I buy. I honestly like having new clothes that fit instead of used hand-me downs. I like having better wine than $2 chuck. I like eating fresh fruits and veggies instead of canned. I enjoy playing my Nintendo Wii and having two dogs. Luxuries all of it. My DH definitely lusts after an iPhone or iTouch. Will it make him happy? Yes. Will he want something more? Doubtful, he’s been lusting after the iphone since it came out and still hasn’t gotten one. Think of it as delayed gratification

Are we materialistic? I guess so. Are we unhappy? Not really. Do we desire to earn more money? HELL YES. But I have very specific goals in mind. I want to be independently well off enough to quit my job if I hate it at the drop of a hat. I want to be able to pay for my children’s college, and maybe even a home down payment or wedding. I want to be able to drive a car without worry that it’ll break down all the time. I want to be able to provide for my parents (and in-laws) in case they need financial support.

So yes I’m materialistic. I’m also realistic. Money may not buy happiness, but it sure helps. Being poor doesn’t mean you are any happy. One could argue you are even more unhappy because you struggle to get out your circumstances. That you would love to new clothes, fresh food, etc.

So maybe over materialism breeds unhappiness. People who just spend for the sake of spending. People who are thousands of dollars in debt and need to go to debtor’s anonymous. Or perhaps those rich people who can spend money like water and never run out. Then perhaps materialism breeds unhappiness.

But to me it’s not materialism that breeds unhappiness. It’s the person themselves. It’s not about material goods. You can have no material goods and be unhappy. Happiness is from within and wanting material goods doesn’t make you a bad person.

Thanks to Lazy Man for allowing me to do this guest post. Please stop by my blog, I enjoy tons of feedback.

Filed Under: Psychology Tagged With: discontent, dogs, Financial Freedom, iphone, materialism, money magazine, nintendo wii, unhappiness, wii

Money’s 7 New Rules of Financial Security (Part 2)

March 25, 2009 by Lazy Man 5 Comments

I’m reviewing Money Magazine’s 7 New Rules of Financial Security. You can read Part 1 here.

Rule No. 4: Borrowing

Old thinking: Borrowing sensibly is a good way to build wealth.
New rule: Borrow cautiously. You have to worry about the other guy’s debt too.

Money Summary: Credit was cheap and plentiful like food at Sizzler. Americans acted as expected and ate as much as they could. Now there’s lots of vomiting going on. Next time don’t eat so much. (Sorry, that might not have been Money’s exact point, but I couldn’t avoid the analogy.) Side point, you may be exposed to more leverage than you think. People paying you money may have been leveraged… their leverage becomes your problem when they can’t pay you.

Lazy Man’s Take: Sounds like money is saying that moderation is the key. Hmmm, I remain unconvinced that’s a new rule. I do like the side point though. It’s something that I hadn’t thought about. I had done a lot of investing with Prosper and have found the returns not very good (though my Lending Club returns have been great). Perhaps everyone else’s leverage became my leverage.

Rule No. 5: Housing

Old thinking: You can expect your house to appreciate handsomely over the long run.
New rule: Your home won’t make you rich. But it is an important savings tool.

Money Summary: Except for two decades where real estate had skyrocketed real estate has been in line with inflation. Real estate also has other issues when it comes to investing in it: maintenance costs, insurance, taxes, remodeling costs that rarely pay for themselves, and steep buying and selling costs. Still owning a home is a great “‘commitment device,’ or a tool that forces you to save.”

Lazy Man’s Take: There’s a great chart with the article. It’s well worth clicking over to. I’ll be here when you back. Done? Good. Back in May of 2007, I suggested the housing run up may be due to more people having dual incomes. Maybe I was wrong and it was government subsidies in the 1940s and easy credit and low interest in the 2000s. If that’s true, there’s going to be a lot of disappointed real estate investors.

As far a commitment device goes, it’s pretty easy to set up an account and automatically funnel money into it. You can invest your money in things with returns that not just in line with inflation, but actually exceed inflation.

Rule No. 6: Diversification

Old thinking: A diversified portfolio lowers your risk.
New rule: Diversification won’t always save you – and you need more of it than you think.

Money Summary: Diversify even more. Get an international bond fund. Use Morningstar’s Internet X-Ray tool.

Lazy Man’s Take: I feel like I already wrote this rule. I love diversification, but I don’t think this is really new. The old thinking and new rule basically say the same thing to me. A lowered risk implies that it won’t always save you. Otherwise the old thinking would have been “diversification eliminates all risk.” I have been using Morningstar’s X-Ray Tool for years now.

Rule No. 7: Retirement

Old thinking: Retiring early is a prize.
New rule: Retiring early is a problem.

Money Summary: With 401k accounts shrinking the odds of retiring early is much more unlikely than it was in the past… and it wasn’t very likely then. Staying at your job for another year could make a big difference in if your money lasts. Lastly, you have to consider that you might not be able to work if you want to – your health and the job market could push you out as you get older.

Lazy Man’s Take: Once again, all solid information, but I’m not sure it’s a new rule. We’ve known for a long time that working an extra year makes a huge difference in retirement income. It’s a year you aren’t withdrawing and are adding to the next egg.

I’m going to stick to the old thinking… The new rule isn’t very motivational.

Filed Under: Investing, Psychology, Retirement Tagged With: dual incomes, financial security, Insurance, leverage, money magazine, Real Estate, savings tool

Money’s 7 New Rules of Financial Security (Part 1)

March 24, 2009 by Lazy Man 6 Comments

Money Magazine’s big headline this month is the 7 New Rules of Financial Security… and Why You Need to Know Them. I have to admit it’s a pretty sweet headline – it certainly caught my eye. I flipped right to page 50 to see what I needed to know why. With that in mind, let’s take a look:

Rule 1: Risk

Old thinking: If you can stomach the ups and downs that come with risk, you’ll be rewarded.
New rule: Risk isn’t about your stomach. It’s about making or missing an important goal.

Money Summary: – Money notes that it becomes much more difficult to retire when you reach a bad stretch in the market. The money you have left over is not enough to build up to where it was. Since you aren’t likely adding new money in retirement, you can’t capitalize on cheap stocks. “This bear market’s lesson is… only risk how much you can lose and still meet your basic goals.”

Lazy Man’s Take:

I didn’t think it was new to only risk what you can lose. I thought that was a universal truth. I see people go into casinos with this mentality all the time (unfortunately not 100% of the time). I agree that it makes sense to bring down your risk exposure as you near retirement. However, the new question is how much? Previous philosophy said that even at age 65, you still may have 15-30 years left, so you need to make your money stretch that long. That requires risk exposure.

Perhaps part of that answer is diversified income streams? Don’t put all your eggs in the equity markets, but have a rental property as well? Perhaps build some businesses that deliver cash flow that can be used in retirement. I don’t know if this website will be around in 35 years (I hope so), but there’s a chance it could get me through some lean years. Just don’t look into selling MonaVie.

Rule No. 2: Cash

Old thinking: Keep enough money in ultrasafe accounts to cover life’s emergencies, but no more.
New rule: Relying more on cash can rescue you in an “asset emergency.”

Money Summary: – The old emergency fund needs to be re-evaluated. Instead you need to look at big potential future purchases in the next three years: “tuition, wedding, down payment on a house.”

Lazy Man’s Take:

I think this is fairly basic knowledge as well. That’s why they have 529 plans that re-adjust with the child’s age to reduce risk. It’s really not much different than the previous rule except it’s not focused on retirement. They could have just as easily said here, “don’t risk what you can’t lose.” I hate to be all bah humbug here, but in an emergency situation weddings can take a back seat. Also, I know few people who need to buy a house. Know what you are risking, and if you are risking too much than know you may have to cut back.

Rule No. 3: Human Capital

Old thinking: The longer your time horizon, the more stocks you should own.
New rule: Time isn’t everything. You must also consider your earnings potential.

Money Summary: – Think about your job security as part of your overall risk profile.

Lazy Man’s Take:

This is sound advice that I don’t often hear. My wife has the near equavalent of tenure at her job. It’s allowed us to be a little more risky than we might have been. I’ve been able to take some time off and work on building other businesses. Put another way, if you are going to be in a band and have a hit song, you might want to put a pile of that money in a safe place in case your the next Soft Cell.

Perhaps this goes back to Rule #1 and diversifying your income streams. You don’t want to be completely dependent on equity markets. In my personal life, I found that someone is willing to value my human capital more than my side businesses, so I switched back to take advantage of that situation. Six months from now, it may be different and I’ll go back to building out my side businesses more and more.

Filed Under: Investing, Psychology, Retirement Tagged With: bear market, diversified income, emergency money, financial security, income streams, money magazine, rental property, risk exposure

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