I'm considering taking a job at a startup which offers zero benefits. I'm trying to assign a value to all the benefits I would be giving up. But I'm sort of puzzled as to how to value the 401k plan. The employer contribution is easy to value, but what kind of value to you ascribe to the employee portion of the plan? Obviously, there's value in making employee contributions to a 401k (otherwise we wouldn't do it). Is it as simple as saying I contribute $S per year to my 401k and my marginal tax rate is r, so the benefit is $S * r?
Not really. In theory, the 401(k) permits a shift from today's bracket,
say 25% to your retirement bracket, say, 10-15%.
But, long term gains for those in the 15% bracket are taxed at zero.
Even in the 25% bracket, they are taxed at 15%, so the benefit of the
401(k) isn't absolute, some of it is mimicked with wise long term
investing. If you really want to assign some number, it's $17,500 * .1
or $1750. Not enough to sway most people either way.
Startup? Stock options?
You have to compute the value of the tax free compounding.
With 401k you have the benefit of tax free compounding. Inside the 401k if you have a return of r1 in dividends/interest and r2 in capital gains you compound at r1+r2, and then apply the expected tax rate (1-t) at the end. Inside the 401k you compound at r1(1-t)+r2. and of course there is no tax rate to apply at the end to the accumulated capital gains. This assumes you are in a passive fund with very little turnover.
You add the final value of the match after applying the tax rate.
Bring the difference in final values back to the present at some discount rate.
If your income is high enough that you are phased out of making an IRA or Roth IRA then you have to include the lost value of that option as well.
It is not a straightforward calculation.
I'm trying to assign a value to all the benefits I would be giving up.
But I'm sort of puzzled as to how to value the 401k plan. The employer
contribution is easy to value, but what kind of value to you ascribe to
the employee portion of the plan? Obviously, there's value in making
employee contributions to a 401k (otherwise we wouldn't do it). Is it as
simple as saying I contribute $S per year to my 401k and my marginal tax
rate is r, so the benefit is $S * r?
Heavens no. You don't save any tax, you simply defer it (in fact, you
may actually be trading what could have been future capital gains for
future ordinary income, with an expected higher tax rate).
Your benefit is the time value of the tax money you will pay in the
future instead of now.
And then, since you most likely would be able to make deductible IRA
contributions, only the difference between your max IRA contribution and
max 401k contribution would be part of the "benefit".
Not tax free, but tax deferred.
or Roth IRA then you have to include the lost value of that option as well.
No one is ever "phased out" of making a traditional IRA contribution.
The deductible amount might be phased out if covered by an employer plan
and income is high enough. Since the question involves NOT being
covered by an employer plan, there would be no restrictions on a fully
deductible IRA contribution, so that amount should be subtracted from
the 401k max amount when comparing a job with 401k to one without.
401k plans often have a sharply restricted list of possible investment choices, while an IRA offers a much wider array of possible choices. So, if everything else is the same, the 401k is a smaller benefit than the IRA.
It might be worth zero - if you wouldn't use it anyway. On the other
extreme, a "high value" case would be that you want to max out a 401k
and are age 50+, and will be limited to using a taxable account or a
non-deductible IRA if you don't have a 401k at work. And, you think your
tax rate will be 0% in retirement so every dime paid to taxes today is
100% lost money, instead of just "paying taxes earlier."
A simple way to value that benefit today is what you'd mentioned - the
401k contribution you could make, times your marginal tax rate. So if
the marginal tax rate is 30%, $23,000 X 30% = $6,900. You'll pay that
much in taxes today, and you wouldn't if you had a 401k plan.
You could certainly get more complicated with your analysis, trying to
evaluate the long-term benefit of tax deferral on the invested money,
but that raises questions about what you'd do with the money in the 401k
vs the alternatives, tax rates along the way, tax rates at retirement,
and when you'd spend the money.
Thank you to everyone who replied. I now realize that the situation is far too complicated to model with a few equations. So I did what I always do - I simulated it. The result (for my individual circumstances): I need 37% more pre-tax money to match the after-tax value of a 401k contribution after 36 years. For anyone who wants to check out the spreadsheet, here's the link:
For my specific case, I've assume a marginal income tax rate of 33.75% (28% federal + 5.75% Virginia), a marginal investment tax rate of 20.75%, my investments appreciate at 6.47% and generated dividends at 2.36%. I went out 36 years because I expect to retire in 24 years and my life expectancy is 48 years. Wisdom of Solomon = split the baby.
Of course, this assumes that you never sell the investments in the after-tax account. Small sales for rebalancing purposes won't affect the outcome too much. But larger sales will generate significant capital gains that throw off the whole model. That being said, it shouldn't be too hard to modify the spreadsheet to account for sales.
Please feel free to download the spreadsheet and play with it. It's read-only, but you should be able to make a copy or download it to Excel or OpenOffice. I've tried to make it reasonably user-friendly. Always open to suggestions, critiques, comments, concerns, philosophical entreaties, etc.
I'm not sure a whole IRA vs. 401(k) comparison is necessary, but they
each have some
potential advantages and disadvantages over the other.
- distributions at 55
- may have access to institutional funds or load-waived funds which
either are unavailable or only available with loads to retail investors
- protected by ERISA
- may have loans available
- may have access to employer stock and ability to take NUA eventually
- not considered part of IRA, which may facilitate tax-free Roth
conversions from non-deductible IRAs
- much higher contribution limits
- much wider investment range
- available to anyone with earned income (or spouse with earned
income) (may not be deductible)
- may be much lower-cost than a 401(k) (depends - some 401(k) plans
are super cheap and some are outrageously expensive)
- no need to deal with your employer or former employer regarding your money
As I posted the other day, brokers and advisors are under a lot more
scrutiny now regarding convincing clients to roll over assets from
401(k) plans to IRAs, and for very good reason. Sure, plenty of 401(k)
plans stink (with poor investment choices, high expenses, etc) -- and
by sheer numbers, I'd guess that most such plans aren't great. But the
larger plans from the larger employers are often very good or even
great, and if you did it by dollars in the plans rather than by numbers
of individual plans, I'd guess that the vast majority of money in
401(k) plans is in very good plans with good or excellent low-cost
Unfortunately, folks working for small business and smaller employers
are often stuck with the not so great plans, and I've seen some real
Anyway, the bottom line is that it really depends on the plan.
And in the case of the OP, the differences may not be something one
could assign a dollar value to.
Regardless, if the OP takes a job at an employer who offers no 401(k),
I'd generally *strongly* encourage that OP to continue to put money
away for retirement! Try to max out the IRA (if you weren't already
doing that in addition to the 401(k) anyway), and if necessary, set up
another (taxable) account and shove money in there, too. Just because
an investment is in a taxable account doesn't mean it has to be taxed
terribly. Low cost index(like) funds with low turnover and, especially
if in equities, with low, qualified dividends, can appreciate very
tax-efficiently. You don't get all the other benefits - it's much more
vulnerable to lawsuits or bankruptcy, you can't rebalance without tax
events, it may affect college financial aid, etc -- but those aren't
generally good reasons for avoiding saving and investing.