One Year 401K Gap

User Forum Topic
Submitted by svelte on September 13, 2016 - 8:21pm

I switched jobs this summer and won't be able to join the new company's 401K until Jan 2018. Gulp!

I haven't been in this position in, well, ever!

Recommendations? What can I do with that cash for the next year that is most beneficial to my retirement years?

Submitted by ltsddd on September 13, 2016 - 8:47pm.

Shouldn't you be able to put that in an IRA?

Submitted by Myriad on September 13, 2016 - 8:52pm.

Roth IRA.
Once that is full, use a normal IRA without deduction for any contributions you want to make above the Roth IRA max. Contribute until you can invest in 401k. Wait a year, then roll the IRA into the Roth IRA.

Submitted by ltsddd on September 13, 2016 - 9:13pm.

There's an income limit for Roth IRA.

Submitted by Coronita on September 13, 2016 - 9:52pm.

I think the contributions limits for a Roth and Traditional IRA are the same, but tha the Roth IRA's also get phased out as your M-AGI increases, and could be completely phased out.

If you have no other IRA's (just 401k's), you could do a backdoor traditional IRA to Roth IRA conversion, I believe without incurring any tax consequences if done correctly.

Submitted by svelte on September 14, 2016 - 5:34am.

Thanks.

I did some research based on your comments.

I'm not eligible for the Roth IRA because our MAGI is too high.

I can't deduct contributions from IRA because my spouse is covered by a retirement plan and our MAGI is too high. That pretty much kills any benefit to using a traditional IRA for a year, I think.

SO where else could I put that $$ to approximate what would have went into a 401K?

1. Pay down mortgage. Since current payoff date is a few years into retirement, if I pay it down now I could bring that payoff date in, potentially to equal my retirement date. This has a similar effect to having contributed that $$ to the 401K during 2017.

2. Pay off solar panels. We could also use the $$ that would have went into the 401K to pay off the solar panels. This would have the benefit of freeing up cash now, but really doesn't benefit our retirement any.

I lean towards #1, but am open to other ideas...

Submitted by Coronita on September 14, 2016 - 7:04am.

The purpose of first contributing to the traditional IRA and then converting to a roth IRA is so that you can indirectly contribute to Roth IRA even though your AGI is greater than what is allowed to directly open a Roth.

If you first contributed to a traditional IRA, did nothing with that amount, and then converted it to a Roth IRA, you are indirectly funding a Roth IRA, and futhermore, if you follow certain rules, you wouldn't have a taxable event do the conversion.

Normally, when you do a traditional IRA to Roth IRA, you must pay taxes on your IRA distribution. But since your contribution to your traditional IRA was with after tax dollars, and since you won't have any capital gains on it before you converted it to a Roth IRA, there is no tax event. There are certain specific rules you must follow to do this. It's known as the "pro-rata" rules that you must follow to make sure it's not a taxable event when you convert from Traditional to Roth IRA.

I believe the most important part of this rule is that you don't have any other IRA accounts elsewhere, or this won't work. (Previous 401k accounts, are ok since the IRS treats IRA's and 401ks differently. So you generally should not rollover old 401k accounts into rollover IRA's unless your previous employer doesn't allow you to keep the 401k account OR the fund selection/plan of your previous employer sucks)

Details of backdoor Roth IRA are found here. And as usual, talk to a CPA, since I'm no accountant, and I probably oversimplified things and probably omitted important details for you to get this to work. I'm just giving you the idea of what could be done. Viability and Implementation details are left as an exercise for the reader.

http://www.rothira.com/what-is-a-backdoo...
https://www.betterment.com/resources/ret...

Submitted by Coronita on September 14, 2016 - 7:01am.

The other thing you can consider, svelte, is if your kids are still young and planning to go to college, and you are planning to pay for all/part of it, you can increase your contributions to a 529 plan.

As far as your solar + mortgage question. I would probably just put the extra cash aside and keep it as emergency cash, maybe split it 50/50 with half paying of mortgage and half as emergency cash.

I would mention tax exempt munis, but the moment I do that, I think phaster would hijack this thread.

I would contribute to a Roth IRA via backdoor if I could. Unfortunately, I made the mistake of rolling out one of my previous employer's 401k into a rollover IRA. So I can't do a backdoor Roth IRA without paying taxes for the conversion. But my then again, my current and previous employer both offered a traditional 401k and a Roth 401k account.

Submitted by no_such_reality on September 14, 2016 - 7:24am.

Good ideas, but let's talk about the obvious one.

What kind of company has a 401K that you can't enroll in for more than 6 months? Let alone 18 months. And what are the details around the plan?

If you started this summer, I could maybe see missing some arbitrary 6 months cutoff. Even then, most companies will let you enroll and start contributing to the 401K, you're just not eligible for match until the 6 month mark.

I'd say take a good long look at the plan, verify the management of it, match, vesting, expense ratios, etc. and most importantly, getting your money out when you leave.

Submitted by Coronita on September 14, 2016 - 7:41am.

no_such_reality wrote:
Good ideas, but let's talk about the obvious one.

What kind of company has a 401K that you can't enroll in for more than 6 months? Let alone 18 months. And what are the details around the plan?

If you started this summer, I could maybe see missing some arbitrary 6 months cutoff. Even then, most companies will let you enroll and start contributing to the 401K, you're just not eligible for match until the 6 month mark.

I'd say take a good long look at the plan, verify the management of it, match, vesting, expense ratios, etc. and most importantly, getting your money out when you leave.

Some small/mid size companies do this, for different reasons. It's not necessarily a indication of the health of the company. And so long as it was disclosed this would be the case, it would be one extra negotiation with the company as part of the compensation package.

The biggest issues I've had with my new company's 401k plan, is the lack of fund selection. I don't like the available funds they have, since most of them are these "target retirement" fund of funds. And most funds are actively managed funds versus passive indexes. So, the way I dealt this, was pick only the few index funds that my current plan has, and rebalance the rest of my 401k/IRA elsewhere so that I wouldn't be lopsided. So my current 401k has a lopsided heavy tilt towards large cap blend, mid cap blend indexes, no small cap, no international, and some short term bonds, while as my other accounts have mostly small came, some bonds, and no mid and large cap allocation.

I'm also trying out one of them "robo-advisors" to see when I should rebalance certain things.

Slight highjack (sorry svelte).

Submitted by no_such_reality on September 14, 2016 - 8:37am.

I'm curious what you think those reasons are?

Other than laziness and not thinking it's important?

I'm serious. I can understand a probationary cleaning before enrollment, but nearly 18 months with what appears to be a once a year enrollment?

I've seen this at some small firms but not to this extent and just my anecdotal observation, the lack of importance they place on having this critical compensation component for their employees permeates a lot of activities in the company.

I get they don't have great fund selection, that's a side effect of being small and herded into fee generating plan by the servicer. (that has it's own concerns)

Submitted by harvey on September 14, 2016 - 9:22am.

I have my own company with one employee - myself - and I was able to start participating in a 401K day one.

It does sound odd that there is a delay of more than a year. I'm no payroll accountant but I cannot even guess as to why a company would have this policy.

As for advice: If you are over the income limits for Roth and traditional IRA contributions I don't think there's are any options that stand out as clearly better. Of course if you have high interest debt, paying that down is a no-brainer. Otherwise just save/invest it in a brokerage account as you would do normally.

Submitted by flu on September 14, 2016 - 10:49am.

no_such_reality wrote:
I'm curious what you think those reasons are?

Other than laziness and not thinking it's important?

I'm serious. I can understand a probationary cleaning before enrollment, but nearly 18 months with what appears to be a once a year enrollment?

I've seen this at some small firms but not to this extent and just my anecdotal observation, the lack of importance they place on having this critical compensation component for their employees permeates a lot of activities in the company.

I get they don't have great fund selection, that's a side effect of being small and herded into fee generating plan by the servicer. (that has it's own concerns)

In the bay area, some companies did this as one of many ways to discourage you from leaving within one year, similar to sign on bonus fine print that stated you had to return the bonus if you left within a year. I guess there is also an administrativr pita of dealing with plans when the employee doesnt stay that long

Submitted by Myriad on September 14, 2016 - 2:06pm.

flu wrote:

I would contribute to a Roth IRA via backdoor if I could. Unfortunately, I made the mistake of rolling out one of my previous employer's 401k into a rollover IRA. So I can't do a backdoor Roth IRA without paying taxes for the conversion. But my then again, my current and previous employer both offered a traditional 401k and a Roth 401k account.

Thanks for writing out in more detail what I was trying to say in shorthand.
You're right about the pro-rata rule. If you don't have that issue, then a nondeductible IRA is similar to an After-Tax 401K. as donated by this post.
https://www.kitces.com/blog/irs-notice-2...

I'm currently doing the after-tax 401k since I've maxed mine out. I debating on switching to the nondeductible IRA, since I suspect the Back-door IRA strategy will be closed in the next administration.

Submitted by svelte on September 14, 2016 - 6:33pm.

Thanks for the thoughts all.

I'm not thrilled by the almost 1.5 year wait, obviously, but the benefits of joining the firm way outweighed the 401K issue so I jumped. Still glad I did, just trying to offset the one negative of jumping - the 401K start period.

Their policy is that a new employee is not eligible to join until their 1 year anniv, then they have to wait until the next enrollment period which is every 6 month. Since I started in Aug, I'm not at one year until Aug 2017 and next open enrollment is Jan 2018. Ouch. One good part is that I cashed out a good chunk o change at the old place and they took a boatload out for 401K, so it really feels more like a year of donations missed, not a year and a half.

Can't for the life of me understand what good that wait does the new company, as I'd be putting in MY money not theirs. Waiting a year to start their match I can see, but waiting on my part? Makes no sense.

My wife is an accountant and says she sees a lot of companies with that rule, though many are shortening it now.

Flu, thanks for the back door explanation. Probably way more work and risk than I want to put in - after all, the max I could put into an IRA is just a fraction of what I'd put into a 401K in 2017...think I'll consider your other suggestion of putting part towards mortgage and a part under the mattress. I'll run the numbers of how much I'd have to throw at the mortgage to have it paid off when I'm 67, that might steer me towards the right split.

I also should check to see what fund choices they offer - hopefully it isn't crappy! That might influence my decision on how long I stay.

Again, thanks all. It never ceases to amaze me the weird positions I find myself in.

Submitted by dumbrenter on September 14, 2016 - 6:57pm.

You cannot put money in 2 401k plans in the same year.
Something I found out the hard way because the employer assholes never told me that (they have no incentive to tell you that).

What I ended up doing few years ago (when still a wage slave)was to max out the 401k in the first 2 months. You can do that by setting 99% of your wage to go to 401k. It automatically stops once you hit the limit for 401K that year.

That way you de-risk yourself from having a taxable event with larger income + any signing bonus you might have gotten for your new job this summer!

As for the cash, I suggest you invest in your regular investment account (not IRA or roth) and invest a little more aggressively based on when you think you will retire

Submitted by ltsddd on September 14, 2016 - 7:12pm.

here's another angle to look at it. The assumptions are that you are closer to retirement than aren't and that you have participated in the 401k plan for many many years (20, 25, 30?). In other words you already have a sizable 401K balance. If that's the case and if I were you, just kick it and enjoy the "windfall". At this point in your life, the yearly addition to the plan is really negligible. The only reason why people want to continue to sock it away is because a) they can b) get the matching c) tax break. Since none of these applies to you there's no need to worry about it. Splurge a little bit. Surprise your SO with a nice vacation or some fancy stuff.

Submitted by Coronita on September 14, 2016 - 7:32pm.

dumbrenter wrote:
You cannot put money in 2 401k plans in the same year.
Something I found out the hard way because the employer assholes never told me that (they have no incentive to tell you that).


That's a rule that your employer made up, it's not a general rule for all 401k plans for all companies. My two previous employers and my current employer have both a traditional 401k and roth 401k plan, and allowed you to allocate any percentage between the two. The only thing that my previous employers stipulate is the annual 5% base salary company match they give you gets deposited in the traditional 401k portion, not the Roth portion. I thought this was some IRS rule, but one person here mentioned that her employer deposits 401k matches in her Roth 401k, so I guess that's not an IRS rule either, but a varies depending on company.

Quote:

What I ended up doing few years ago (when still a wage slave)was to max out the 401k in the first 2 months. You can do that by setting 99% of your wage to go to 401k. It automatically stops once you hit the limit for 401K that year.

That strategy many not work if your employer does a company match and limits the maximum match per pay period to the maximum amount prorated based on each month... For example, my employer matches 5% of your annual salary, but the maximum they will contribute per pay period is 5%/26 (we're on a bi-weekly pay period). So if you contributed 99% into the first few weeks of the pay period, I don't believe you will get the full 5% match for the remaining months, just the months you actually contributed to the 401k.

Quote:

That way you de-risk yourself from having a taxable event with larger income + any signing bonus you might have gotten for your new job this summer!

The maximum tax deferral you can take is $18k. It makes no difference if you take it up front, or spread it out over the months. It might make a difference if you believe there are certain months that tanks market tanks, like for instance if you believe in the sell in may, go away until october. But what people usually do there is to just change the investment elections during those month to be more heavy in cash positions versus stock poitions. It also might make a difference if you have a cash flow issue because you're trying to max out your 401k AND trying to max out your after tax ESPP stock plan, since those withholdings are with after tax dollars and you won't get them back for a quarter or in some cases 6 months, until the share purchase, when you can sell.

Submitted by Coronita on September 14, 2016 - 7:41pm.

svelte wrote:

Flu, thanks for the back door explanation. Probably way more work and risk than I want to put in - after all, the max I could put into an IRA is just a fraction of what I'd put into a 401K in 2017...think I'll consider your other suggestion of putting part towards mortgage and a part under the mattress. I'll run the numbers of how much I'd have to throw at the mortgage to have it paid off when I'm 67, that might steer me towards the right split.

I also should check to see what fund choices they offer - hopefully it isn't crappy! That might influence my decision on how long I stay.

I wouldn't worry about it, you're not going to miss *that* much money from waiting extra year. Who knows, maybe you won't lose money during that 1 year, in case the stock market tanks. So you never know, maybe there's reason for this after all :)

You definitely should check the sort of funds they offer. A shitty 401k plan will stick you with managed funds that have huge hidden fees/costs, and very little selections of funds that mirror index funds. Index funds are meant to be passive/low cost funds, and a lot of 401k plans don't have them because the plan administrator obviously wants to make money by offering those actively managed funds.

The other thing you want to check at a small company is if there are any specific rules/restrictions as to when you can do exchanges, and how often you can do exchanges, if there are any sort of extra costs from doing exchanges, and if there are any fees to roll out of the account or transfer out of that account. In my new employer, they were adding a few new funds two months ago. And while they were doing that, the plan administrator locked out anyone from exchanging their funds for about 6 weeks.

The other thing you want to check at a small company is how before one paycheck's contribution makes it into a 401k account. This should not be longer than 1 week. If the company is doing something shady, you won't see the funds for several weeks.

Submitted by Coronita on September 14, 2016 - 7:48pm.

Oh, and if you happen to be have made a mistake and rolled over a 401k into a rollover IRA, making you ineligible for a backdoor Roth IRA with no tax consequences...there is one workaround you can consider.....

If your current employer's 401k plan is decent and your current employer's 401k plan allows it, you can roll in your rollover IRA into your companies 401k plan. Again, the IRS treats the 401k plans differently from IRA accounts. So it doesn't matter how much money you have in any of the 401k accounts of previous employers.

Submitted by livinincali on September 15, 2016 - 10:18am.

flu wrote:

I wouldn't worry about it, you're not going to miss *that* much money from waiting extra year. Who knows, maybe you won't lose money during that 1 year, in case the stock market tanks. So you never know, maybe there's reason for this after all :)

The only thing your really missing out on is the tax benefit. You can open a standard brokerage account and likely invest in the same shitty funds the 401K offers. The question of paying down a mortgage versus investing really just comes down to rate of return and any kind of possible tax advantage/disadvantage. If you pretty confident you can get a rate of return a couple percent higher than the mortgage rate do that. If you can't then pay down the mortgage.

Submitted by Coronita on September 15, 2016 - 10:29am.

livinincali wrote:
flu wrote:

I wouldn't worry about it, you're not going to miss *that* much money from waiting extra year. Who knows, maybe you won't lose money during that 1 year, in case the stock market tanks. So you never know, maybe there's reason for this after all :)

The only thing your really missing out on is the tax benefit. You can open a standard brokerage account and likely invest in the same shitty funds the 401K offers. The question of paying down a mortgage versus investing really just comes down to rate of return and any kind of possible tax advantage/disadvantage. If you pretty confident you can get a rate of return a couple percent higher than the mortgage rate do that. If you can't then pay down the mortgage.

The tax benefit is would be roughly 1.5 years worth of Roth 401k contribution roughly $7750... Assuming a 4% conservative ROI over the next 10 years, that would be roughly $11k available at retirement. If he has a mortgage or loan amount above 4%, perhaps paying off of the higher interest debt would be a better option.

Yes, it's money, but not completely devastating..Who knows, maybe svelte got more than an $11k net raise (after taxes). I guess it depends on how much of a hassle does svelte want to deal with setting up a backdoor Roth (and whether if he can).
For me, I don't mind dealing with PITA things when it comes to money. But that's just me.

Submitted by no_such_reality on September 15, 2016 - 10:39am.

livinincali wrote:

The only thing your really missing out on is the tax benefit.

Head bang wall.

He's stated that his MAGI is too high for Roth. So their MAGI is north of $194K for a couple.

As such, his marginal tax bracket is 9.3% if not 10.3% in California and another 28% for Federal.

Combined a 37% tax hit. So to park that $18K max 401K contribution in a regular brokerage, he's going to have to allocate $28.5K to pay the $10K+ in taxes and put the $18K in the brokerage. Any realized additional income or gains during the year are also taxed.

Last I checked, a 58% one year return with virtually zero risk was pretty good.

Submitted by Coronita on September 15, 2016 - 10:45am.

no_such_reality wrote:
livinincali wrote:

The only thing your really missing out on is the tax benefit.

Head bang wall.

He's stated that his MAGI is too high for Roth. So their MAGI is north of $194K for a couple.

As such, his marginal tax bracket is 9.3% if not 10.3% in California and another 28% for Federal.

Combined a 37% tax hit. So to park that $18K max 401K contribution in a regular brokerage, he's going to have to allocate $28.5K to pay the $10K+ in taxes and put the $18K in the brokerage. Any realized additional income or gains during the year are also taxed.

Last I checked, a 58% one year return with virtually zero risk was pretty good.

Not to be nit picky about this...But his tax rate may not be 37%, more likely around 29% combined. He does have a mortgage, i believe, but would get hit most likely with AMT. My tax rate will be more like 37% combined this year though, since well, one of the things about not having a mortgage:(

Submitted by no_such_reality on September 15, 2016 - 10:49am.

Yea well, math mistake on my part too.

I'm talking marginal. He'd have to be close to the bottom limit on the MAGI to get below the $151K and that'll shave 3% off the Fed rate.

I doubt they drop their AGI below $103K to get under the 9.3% Cali rate.

So maybe 34.3%

Either way, and even at the much lower 29%, getting a zero risk 29% return would make most fund managers drool.

Submitted by plm on September 15, 2016 - 11:25am.

The 401K is just tax deferred so that needs to be taken into account in the math. Taxes will have to be paid at some point. I wonder if the rate could actually be higher when you retire and the way I understand it, you have to start taking money out at a certain age.

Backdoor roth ira took me several days to figure out and about a week to execute. But once you have all the accounts set up it and taxes figured out shouldn't be too hard to repeat. Hopefully doing it again this year will be easier.

Submitted by flu on September 15, 2016 - 1:09pm.

plm wrote:
The 401K is just tax deferred so that needs to be taken into account in the math. Taxes will have to be paid at some point. I wonder if the rate could actually be higher when you retire and the way I understand it, you have to start taking money out at a certain age.

Backdoor roth ira took me several days to figure out and about a week to execute. But once you have all the accounts set up it and taxes figured out shouldn't be too hard to repeat. Hopefully doing it again this year will be easier.

Yes, if you saved a lot in your pre tax retirement accounts, you could be subject to higher tax rate during your retirement than right now, if your annual required minimum distribution (RMD) is more than what your AGI was when you were working.

Also, you would be subject to the tax rate during that time, which lets face it, will be more than it is now, given the way this country spends....RMD doesn't kick in until 70.5 I think...a lot of good retirees I know are facing this right now.
Its funny, because one person I know calls their 401k retirement plan the biggest scam for avid savers. His argument is 401k had shitty fund selections that subjected him to a bunch of fees to fatten the fund companies. And that now that he saved so much, his RMD is 2x what his AGI was when he was working. So his tax rate is also much higher now, and hence his argument is this was a beautiful con to get avid savers to pay more taxes. Also, since he never borrowed against his 401k, he claims this money was pretty much dead for use all those years.

He told me he regrets contributing so much to his 401k, and wishes he had just contributed enough to get the company match and then put the rest of his money after tax on real estate, when things like depreciation and other itemized deduction and things like like 1031 exchanged do a wonderful job sheltering money indefinitely... I don't know if I agree with him, but it was an interesting comment to hear.

Submitted by SK in CV on September 15, 2016 - 1:10pm.

bullishgurl wrote:
Yes, if you saved a lot in your pre tax retirement accounts, you could be subject to higher tax rate during your retirement than right now, if your annual required minimum distribution (RMD) is more than what your AGI was when you were working.

Also, you would be subject to the tax rate during that time, which lets face it, will be more than it is now, given the way this country spends....RMD doesn't kick in until 70.5 I think...a lot of good retirees I know are facing this right now.

You need a shit-ton of money in retirement accounts for tax rates to be higher post-retirement. RMD at 70, if spouse is sole beneficiary and less than 10 years younger is about 3.6% of value as of 12/31 of the prior year. So to get even to a $100K RMD, it requires almost $3 million in the account.

I do know people with substantially more than that in retirement plans, but they're in a high tax bracket even if they had no RMDs.

That said, I think a 50/50 split of traditional/roth into 401K's is a great way to go. Particularly for those that qualified retirement plans are expected to provide substantially all of their retirement funding.

Submitted by flu on September 15, 2016 - 1:16pm.

SK in CV wrote:
bullishgurl wrote:
Yes, if you saved a lot in your pre tax retirement accounts, you could be subject to higher tax rate during your retirement than right now, if your annual required minimum distribution (RMD) is more than what your AGI was when you were working.

Also, you would be subject to the tax rate during that time, which lets face it, will be more than it is now, given the way this country spends....RMD doesn't kick in until 70.5 I think...a lot of good retirees I know are facing this right now.

You need a shit-ton of money in retirement accounts for tax rates to be higher post-retirement. RMD at 70, if spouse is sole beneficiary and less than 10 years younger is about 3.6% of value as of 12/31 of the prior year. So to get even to a $100K RMD, it requires almost $3 million in the account.

I do know people with substantially more than that in retirement plans, but they're in a high tax bracket even if they had no RMDs.

That said, I think a 50/50 split of traditional/roth into 401K's is a great way to go. Particularly for those that qualified retirement plans are expected to provide substantially all of their retirement funding.

He has a shitload of money in his 401k but made a middle class income during his prime years by bring an complete miser. HE was also one of those guys that had a pension in the defense sector as a machinist that is also adding to the AGI in his retirement years, so I guess combined, his tax rate is much higher than when he was working.

Some of his colleagues are in the same boat.

But I agree with you on the 50/50 split, which is what I do.

Submitted by Myriad on September 18, 2016 - 5:57am.

bullishgurl wrote:

He has a shitload of money in his 401k but made a middle class income during his prime years by bring an complete miser. HE was also one of those guys that had a pension in the defense sector as a machinist that is also adding to the AGI in his retirement years, so I guess combined, his tax rate is much higher than when he was working.

Some of his colleagues are in the same boat.

But I agree with you on the 50/50 split, which is what I do.

Seems like a 1st World problem - too much money and now has to pay more tax!

But seriously, that's why the roth 401k vs traditional 401k is complicated. You have to project what your retirement tax rate is.
I agree with the 50/50 roth/traditional since it provides tax diversification in retirement.
Since the person had a pension, with SS, it's probably fairly easy to be in a higher tax bracket if his income was average when he was working.

If you do have a large 401k balance, you have to withdraw money from your 401k as soon as you retire (retire early) and slowly move the money to a roth. Once you hit 70.5, the RMD can not be used for a roth. Only once you hit 70.5, you take SS and potentially withdraw money from the roth. So basically burn as much money from a traditional 401k/ira before you hit RMD,

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