Given a 10 year timeframe, if I am investing the same amount of money,
with the same expected returns of the underlying funds, is it better
to invest inside of a 401k portfolio of mutual funds and take the
penalties associated with early withdrawl or invest inside of a
traditional portfolio of mutual funds?

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Clarification of Question by ikoskela-ga on 15 Aug 2006 17:54 PDT

also, for this scenario, i am 30 years old.

I would say put the money in a 401k based on tax rates.

With the 401(k) you will pay ordinary income tax on everything ater a 10% penalty.

With the portfolio, you will pay ordinary income when you get your
salary + pay capital gains and taxes on dividends (about 15%).

Are you sure you have to pull out of the 401k subject to the 10%
penalty? ;some policies allow for hardship withdrawals or for
educationorto purchase a home.  Or take a policy loan if you feel you
need some money.

Please keep in mind, my answer is a generalizationl; i do not know
your circumstances.

In this theoretical scenario, do you get a company match for
contributions to your 401(k)?  That's often one of the most attractive
elements of an employer's 401(k) plan, and your 10 year time frame is
long enough so that you'd likely be fully vested in any contributions
made by your employer.

yes, the company matches dollar for dollar up to 6%.

ok. i see a problem in how i calculated the return for the mutual
fund. I used an ordinary tax rate for the gains instead of the capital
gains rate. After re-calculating, the mutual fund portfolio gives
slightly better performance. This does not take into account any
matching so i would think the best strategy, given my scenario, would
be to contribute to the 401k as much as the company will match and put
the rest in the mutual fund portfolio.

year	salary	invested	401k balance	401k after penalties	mut.fund
0	85000	14450.00	15895	        9537	        10974.775
1	85000	14450.00	33379.5	        20027.7	        22882.40588
2	85000	14450.00	52612.45	31567.47	35802.18537
3	85000	14450.00	73768.695	44261.217	49820.14613
4	85000	14450.00	97040.5645	58224.3387	65029.63355
5	85000	14450.00	122639.621	73583.77257	81531.9274
6	85000	14450.00	150798.583	90479.14983	99436.91623
7	85000	14450.00	181773.4413	109064.0648	118863.8291
8	85000	14450.00	215845.7855	129507.4713	139942.0296
9	85000	14450.00	253325.364	151995.2184	162811.8771
10	85000	14450.00	294552.9004	176731.7403	187625.6617

If your need for the money comes from early retirement then you can
avoid paying the 10% penalty.
"if you actually plan to retire before age 59 1/2, you can avoid the
penalty for early withdrawal simply by taking a series of
substantially equal payments. The people who have to pay penalties are
people who make one-time or short-term withdrawals."
--http://www.uexpress.com/scottburns/index.html?uc_full_date=20020228

There are usually ways to avoid paying excessive taxes or penalties
with a little planning.  10% is quite a chunk and you should avoid it
if at all possible.

jack_of_few_trades - Thanks. Recalculating by removing the 10% penalty
puts the 401k investment slightly ahead of the mutual fund portfolio.
Best strategy = Max out the 401k and put the rest in the mutual fund
portfolio.

year	salary	invested	401k balance	401k after penalties   mut.fund
0	85000	14450.00	15895	        11126.5	        10974.775
1	85000	14450.00	33379.5	        23365.65	22882.40588
2	85000	14450.00	52612.45	36828.715	35802.18537
3	85000	14450.00	73768.695	51638.0865	49820.14613
4	85000	14450.00	97040.5645	67928.39515	65029.63355
5	85000	14450.00	122639.621	85847.73467	81531.9274
6	85000	14450.00	150798.583	105559.0081	99436.91623
7	85000	14450.00	181773.4413	127241.4089	118863.8291
8	85000	14450.00	215845.7855	151092.0498	139942.0296
9	85000	14450.00	253325.364	177327.7548	162811.8771
10	85000	14450.00	294552.9004	206187.0303	187625.6617