I am trying to see what makes most sense, tax wise:
- I am 30, not concerned at all about retirement
- not an US citizen, one day I might have to cash out and leave
- last year my effective federal tax rate was 18.76%, and state rate was 5.51%, this year a little bit higher
- I already get the most out of my employer: 4% when I contribute 5%
- I can easily add more to my 401k, I invest most of my income anyway
Is it better to use pre-tax money to fund my 401k and not have easy access to them for 30 years, or save/invest with after-tax money?
Basically: "possibility of lower taxes 30 years from now" vs. "taxes and penalty if I decide to cash out"!
Comments
You can't get any better advice than the above. The greatest wealth creating tool is the tax free compounding of capital over time. The best move I ever made as a trader/investor was to open an IRA. The dumbest move I ever made was to not covert my IRA (because I did not want to pay the tax obligation) to a Roth when they became available in the late 90s.
My income is right in there, how do I know how much I can contribute? What happens if I contribute more than I should?
Hear, hear Junkster and rest of board: Just great that you are taking advantage! That said, consider finding way to purchase a house as well, especially on any "excess" you mention below.
Good luck.
http://www.irs.gov/publications/p590/ch02.html
FWIW, I echo the sentiments of Mozart & Junkster. In addition to the tax-free compounding the opportunity to access the money in certain cases after 5-years is compelling.
A 28% marginal tax bracket does not strike me as low.
For a US citizen, I would say that if you are maxing out all your tax shelters, then go post-tax, because that lets you get more money sheltered. That's because you're putting in post-tax dollars, worth 1/3 more (a pre-tax dollar being worth only 75c upon withdrawal and taxes). By post-tax, I mean Roth 401K and/or Roth IRA.
Even if one wound up paying 28% now vs. 25% later, the additional amount you get to shelter makes this worthwhile. But I haven't checked the taxation of nonresident foreigners, so I don't know those calculations.
If one is not maxing out, then contributing pre-tax can come out better (if one assumes a lower tax rate upon withdrawal). For example, if you contribute $1 pre-tax, and take it out at 25% tax bracket, you've contributed 75c post-tax value. If you take that same dollar now, pay 28% tax on it, then you contribute only 72c to a Roth. (This assumes you don't have extra cash to contribute another 28c, which is where the "maxing out" assumption comes in.)
As to cashing out when you leave - it seems you should be able to transfer the 401k money to an IRA (based on the statement above that foreigners can own Roth IRAs).
Note that contributing pre-tax to the 401K might reduce your AGI enough that you could contribute the full amount to a Roth IRA.
As to what happens if you contribute too much, see Fairmark. Short answer - pull the excess (including earnings) before your taxes are due, otherwise penalties are harsh. Easy to correct.
Stay warm, Derf
But I don't exactly know what my income is. Other than my salary I have my money in funds. I haven't sold any of my funds, but I have received dividends and capital gains that were directly reinvested. Are those considered as income when calculating the Roth IRA limit?
Don't forget that 401K's/company pensions/in many States, IRA's provide legal protections against creditors that taxable accounts do not. OJ Simpson knows all about that for sure.