Should I opt out of my 401(k)?
I am 23 years old and currently have a 401(k) account at work. I recently got a raise and now I make less than when I started (because of the higher tax bracket). I want to opt out of my 401(k) and put the funds into a different account. Where should I move this money to?
First, I think it is great that at 23 you are contributing to your 401k. There may come a day when you have other short term commitments such as a birth of a child and your spouse may need to stay home for a bit and feel you need to temporarily cut back on contributions so you have more take home pay.
I urge you to continue contributing regardless of the higher tax bracket this. Contributions to your 401k actually lower your taxable income so I think it makes even more sense to continue these deposits.
If you feel you still want to stop, I suggest contributing enough to at least get the company match if that is offered.
Congratulations on your recent raise! I would like to address several issues I think you have raised in your question. First, if you are making less money in your take-home paycheck than you were before your raise, it is more likely related to money being withheld for benefits than it is your new tax bracket. Tax brackets work like buckets, and you fill the buckets of the lower tax brackets before you move onto a higher rate. As a result, your nominal tax rate (the highest rate you pay) is not the percentage of tax that you owe for all of your money. You have gotten the benefits of those lower brackets, as well. Even though you have moved to a higher tax bracket as a result of your raise, that bracket is only used for money in excess of the bracket you were in.
It's possible, though, that your paycheck has gone down. You will want to talk to your HR department to examine the costs of any fringe benefits you may be purchasing. For example, maybe the cost of supplemental life insurance has increased at your firm. These changes can be the result of a new carrier, as well as other potential issues. Your HR department will be able to help you better with this much better than I can!
Finally, you don't say why you want to opt out of your 401(k). It's very possible that your employer will match contributions that you make up to certain percentages. For example, some employers will match your contributions up to the level of 3% of your compensation. If you opt out of this, you are turning down free money up to the level of the match. If your employer makes contributions on your behalf regardless of your participation you should know that this makes you an active participant in the plan, even though you aren't putting in any money, yourself. Active participation in a company plan can impact your ability to deduct an IRA contribution. This isn't a bad thing, but it's something you need to know. I have heard some financial celebrities be very critical of 401(k) plans, but an employer match gives you an effective 100% return on the money you choose to defer. Even if the fund choices aren't great or they are somewhat expensive, you should really consider participating, at least up to the level of the match.
Of course, your circumstances may change the usefulness of my response. My answer is educational, not investment advice. Investing is risky, and you can lose money. Consult a financial professional before you make any decisions. Be Prosperous!
Certain aspects of your question puzzle me.
People do not make less overall when they move up a tax bracket by virtue of getting a raise, since the higher tax rate only applies to the amount by which you exceed the lower limit of the new band you are moving into and not to the whole amount you earn. More likely, if you are netting less than before, something quirky is going on with your payroll and you should talk to your HR department about what may have changed since your pay raise.
On one hand, you appear to be very sensitive to your tax situation, but on the other, you seem to lack an understanding of how a 401(k) works from a tax perspective. As a recent inhabitant of a higher tax bracket, your 401(k) contribution is now worth even more than it was before and this is precisely the wrong time to stop contributing!
If, for example, the tax bracket you have just moved up to is the 35% one, then it will effectively cost you only $65 to invest $100 in a 401(k) and then get tax-deferred growth for at least the next 37 years in your case, as opposed to costing you $100 to invest $100 in a regular taxable account.
Also, as other advisors have mentioned, if you get a match at work, ALWAYS contribute whatever it takes to get that match. HR will tell you how much that number is. That is effectively the same as earning a guaranteed 100% return on your investment. Good luck finding anything like that anywhere else.
The only possible consideration why you may want to even think about making contributions to an IRA instead of a 401(k) (at least for $5500, the IRA limit) over and above the match (contributing to the match should non-negotiable) is if the investment choices in your plan are so bad, and so expensive, and so limited. While most 401(k) plans are INDEED littered with expensive, actively-managed garbage, there are usually at least one or two more viable options. If you need a CERTIFIED FINANCIAL PLANNER™ to analyze your plan and identify the preferable options, then reach out and hire one on an hourly basis.
Sounds like you’re very tax-conscious. However, if you opt out of the 401(k), you are actually doing the exact opposite of what you want to accomplish. 401(k) is a tax shelter; the more money (up to a limit, $18k for 2016) you can contribute to a 401k, the less income reported on your W-2, and the less taxes you have to pay. Furthermore, by not contributing to a 401(k), you miss the employer’s matching, which is the free money. That’s a double whammy. Therefore, continue to fund your 401(k) to the max, and also set up an HSA (health savings account, $3,350 for single in 2016) if you have a high deductible health insurance plan. Those two maneuvers alone should lower your income about $21,350. Best of luck!
Thanks for the question. Congratulations on the raise and great job contributing to the 401(k); it is very helpful to do so at a young age. Before you decide to opt out of contributing to the 401(k), do you receive a company match? If so, you would be throwing away free money by not contributing.
Additionally, the U.S. has a marginal tax rate system. This generally means that moving to a higher tax bracket is not a bad thing. This is because the higher tax rate is only applied to a portion of your income, not ALL of your income. It sounds like getting some more specific advice from your tax preparer or from a fee-only advisor would be of benefit to you.