Wednesday, February 12, 2014

401k contribution percentage

Posted on 10:04 AM by Unknown
Over at Reddit we came across the following discussion: 401k contribution percentage (self.personalfinance)
submitted  ago by Cmat1
I should start off by saying I'm completely clueless when it comes to this stuff...
My employer offers a 50% match up to the first 6%. Currently, about 10% of my paycheck is going into the 401k each month, with an automatic 1% increase every year.
I'm 28 years old, married, and making about $61k. My wife makes around $34k.
After reading a lot on this subreddit, it seems like most people recommend contributing up the matched percentage, and then putting some into a Roth IRA. Is this accurate? Why is this a better option than contributing a larger amount to a 401k?
Again, completely clueless here so any help is appreciated.
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[–]United StatesaBoglehead 12 points  ago
After reading a lot on this subreddit, it seems like most people recommend contributing up the matched percentage, and then putting some into a Roth IRA. Is this accurate?
Yes.
Why is this a better option than contributing a larger amount to a 401k?
401k fund choices tend to be limited and expensive. With an IRA you get to choose which low cost fund family you invest in. Vanguard, Fidelity, or Charles Schwab are well known low-cost IRA providers.
[–]Cmat1[S] 4 points  ago
This makes sense. My 401k is with T.Rowe, 100% into this . I assume the advice of only contributing up to the match % still stands? There is around $52k in there currently.
EDIT: after reading up on my plan more, I've found out that the company will match 100% up to the first 4%, followed by 50% up to 6%. I assume I'll want to have 6% as my max contribution percentage.
My parents started a Roth for me with State Farm a number of years back. There's about $11k in there now. I have no idea when the last time a contribution was made but I know it's been at least 10 years.
My plan is to move it over to Vanguard then start making monthly contributions. I've heard good things about them with their low costs etc. Is there any particular fund I should be looking at moving into given my situation?
[–]PsyAyeAyeDuck 4 points  ago
EDIT: after reading up on my plan more, I've found out that the company will match 100% up to the first 4%, followed by 50% up to 6%. I assume I'll want to have 6% as my max contribution percentage.
This means that your employer will match up to 5% if you contribute 6% of your salary to your 401k.
[–]United Stateskaspitone 1 point  ago
Not exactly sure what your situation is, but check out Vanguard's Target Retirement Funds. They're low cost and completely hands off and the perfect fund for anyone not keen on balancing their portfolio or finding what funds to invest in.
[–]KhabaLox 7 points  ago
The above suggestion is very good, but I'll still provide an alternative. This requires a little more research and knowledge, but it's arguably a good idea to do a modicum of learning about this since it's such an important part of your financial life.
The alternative is to invest in 3-5 index funds that cover 3 sectors: US Equities, International Equities, and Bonds. For example, you might go with 60% US Equities, 20% International and 20% Bonds.
A rule of thumb I've hear is to allocate your age (or your age less 10) in percentage to bonds, so you probably want to be in the 18-28% range for bonds. Personally I'm a bit lower, but it depends on your risk/reward profile. Bonds are less risky than equities, but provide less return over the long run.
For US equities, you have your choice of a 500 index, which follows the S&P 500, or a Total Market Index, which tracks the entire US equity market. The latter is probably better for a more hands-off approach. If you go with the 500 index, you might want to complement it with an Extended Market index, but doing so is basically replicating the Total Market Index.
For International, you can go with a Total Intl Index, or you can be more specific by focusin on developed economies (i.e. Eur, Japan, Korea, etc.) or Emerging Markets (BRICS, etc.). For simplicity, it's probably best to just go with the Total Intl Market fund.
[–]Dandz 3 points  ago
Vanguard's Retirement Date fund are just a mix of 4 funds, thier total US stock, total Intl stock, total US bond, and total Intl bond. So if you are following the strategy you mention, the TD funds are about the same except they rebalance automatically and are a tiny bit more expensive. Unless you are slicing and dicing to put more emphasis on a market sector (like small caps for an example) a TD fund makes a lot of sense.
[–]KhabaLox 2 points  ago
Agreed. Doing it yourself requires more attention, but allows a little bit of finer tuning.
[–]United StatesKhaloc -2 points  ago
Vtsax and vbmfx. Put [your age]% in vbmfx and the rest in vtsax. If you want more risk/return do [your age -10]% in vbmfx and the rest in vtsax. Readjust the numbers once a year.
[–]worrst 4 points  ago
What if your employer offers Roth 401k with diversified Vanguard stocks/bond plans?
[–]United StatesaBoglehead 5 points  ago
Then it's up to you on which route (IRA or 401k) you take. It's a nice problem to have.
[–]Neil_Armschlong 1 point  ago
I have no 401k match currently but I'm putting 10% into my 401k each paycheck. I also just maxed out my 2013 Roth IRA. Both my 401k and Roth IRA are using the Vanguard Target Retirement Date 2050 (I'm 23). Would you recommend adding more to my 401k or maybe adding in some Vanguard ETF's?
[–]United StatesMindTheGAAP 1 point  ago
The reason you want to be wary of adding in extras to the all-in-one fund is that it can skew your asset allocation. If you like what you're investing in through the 2050 fund (index funds that represent the market as a whole) then keep shoveling money through that. If you want to get more concentrated in small caps or international stocks that go for it - you just need to be aware of the impact it'll have on your portfolio composition.
[–]KhabaLox 0 points  ago
maybe adding in some Vanguard ETF's?
IMO, if you're saving/investing for retirement, you don't need the flexibility ETFs get you, but you pay for that privilege through commissions. If you are DCA'ing (that is, contributing monthly and increasing the holding of your ETF every month), those commissions are going to add up.
After maxing your Roth contributions each year, I would contribute more to your 401(k). It's fine to have both accounts 100% in the 2050 fund. If you max out the 401(k), then you can think about setting up a taxed investment account.
[–]exconsultant32 2 points  ago
Vanguard ETFs trade commission-free if traded directly through Vanguard.
[–]KhabaLox 1 point  ago
Interesting. I didn't know that. I wonder how they can afford to do that. I assume that doesn't extend to options trades on the ETFs, just strictly buy and sell orders?
[–]user41day 1 point  ago
I think even in that case, it's still better to contribute upto match, then IRA. You have the ultimate control over your IRA while your 401k is still up to your employer's discretion (they could change their fund availability on you).
[–]United StatesFiram 2 points  ago
You could do that, but most of the time, even with Vanguard funds, there is some overhead charged by the 401k provider. The most notable exception to this is TSP, which has very low rates, but incomplete international exposure, if you can about that.
[–]worrst 1 point  ago
So lets say in the future you are no longer with the company, can you convert your 401k into a Roth IRA? Are there any penalties?
[–]rbelmont 1 point  ago
Generally (always?) - you can convert the 401k to an IRA when have a change in employment status. Also, worth looking into... some 401k programs offer a feature called an in-service distribution which let's an employee to do a direct rollover into a self-directed IRA. I looked into it a while ago, found out our 401k provider didn't offer this feature, and dropped it. I investigated it enough to think it was an option for me, as long as I put the money to work in other investments in short order. But there's a lot of information (some of it bad information) about the rules on in-service distributions that you'll need to investigate.
[–]KhabaLox 1 point  ago
You can roll a Roth 401(k) into a Roth IRA, and you can roll a Traditional 401(k) into a Traditional IRA.
The rollover options for a Roth 401(k) follow those of a traditional 401(k). That is, you can roll the funds over to an IRA or into a new employer's 401(k). Just like the distribution of a traditional 401(k) is moved into a traditional IRA, the distribution from a Roth 401(k) rolled into a Roth IRA. If your new employer has a Roth 401(k) option and allows for transfers, you may also be able to roll the "old" Roth 401(k) into the "new" Roth 401(k).
[–][deleted]  ago
[deleted]

    [–]worrst 1 point  ago
    What do you mean Roth IRA =/= IRA? There's traditional and Roth IRA, no? Yes, I know IRA does not have anything to do with my job.
    [–]judgemebymyusername 1 point  ago
    Disregard.
    [–]judgemebymyusername 1 point  ago
    Tax diversification is the main reason to split between 401k and Roth once you've hit your employer match. Most of what I've read suggests 401k to match, then max out Roth, then max out 401k, then taxable accounts. Paying off debt should be somewhere in there too of course.
    [–]worrst 1 point  ago
    So if reading correctly then if there is a Roth 401k plan then it shouldnt matter if I max it out on my Roth 401k first or Roth IRA since neither one of them will be taxed in the future. Only service fees if it applies to any.
    [–]judgemebymyusername 1 point  ago
    That is correct. But there are conflicting viewpoints on going 100% Roth.
    I highly suggest skimming through this http://www.bogleheads.org/wiki/Roth_versus_Traditional
    [–]duhhhh 1 point  ago
    I see a few cases to go 100% Roth.
    1) You are young and low expense/low tax bracket now. It makes sense to contribute as much as you can to Roth IRA and Roth 401k. You can contribute to a traditional 401k later when you are in a higher tax bracket and have family expenses of your own.
    2) You are older, plan to start a pension/social security as soon as you retire, and have been contributing to a traditional 401k for many years. If you won't have significantly lower income in retirement, then maxing out a Roth 401k today allows you to save more in retirement accounts and balance out your earlier traditional contributions. If you plan several years between retirement and pension/social security, then it probably makes more sense to roll some of the traditional assets at that lower income point instead.
    3) You have kids you expect to go to college and you want to have few assets to maximize financial aid. Home equity and retirement accounts do not count as assets for financial aid. So maxing out a Roth 401k shelters more of your savings than maxing out a traditional 401k.
    [–]judgemebymyusername 1 point  ago
    For #3, that frustrates the hell out of me. My parents contributed no help to my college, and I plan on doing the same for my children. Parental assets should not be part of the fin aid calculation IMO.
    [–]Thisismyredditusern 2 points  ago
    On the other hand, my parents paid for my schooling and I pay for my kids' schooling. I guess it wouldn't matter if all aid were purely merit based, but much of it is needs based. They have no easy way of distinguishing between your family and mine and if you start giving money away, people are often not honest. They err on the side of not giving people like me free money. I don't think that's a bad thing. Or they could just get rid of needs based aid.
    [–]judgemebymyusername 1 point  ago
    People need needs based aid. But it's unfair to assume that parents will give their children money. I was ineligible for some scholarships because of the FAFSA calculation.
    [–]Thisismyredditusern 1 point  ago
    Do you think the kids whose parents were supporting them should have had the same access to the financial aid you wanted?
    [–]ZoraQ 3 points  ago
    Some 401K plans offer brokerage options that allow you to move your 410K funds into a brokerage account under the 401K umbrella. This opens your options to all the funds that your brokerage house offers without the 401K fees. I do this under my 401K with fidelity and invest in Fidelity and non-Fidelity funds. OP may or may not have this option but may be worth investigating.
    [–]United StatesaBoglehead 1 point  ago
    Indeed. Good point.
    [–]KhabaLox 2 points  ago
    After reading a lot on this subreddit, it seems like most people recommend contributing up the matched percentage, and then putting some into a Roth IRA. Is this accurate?
    Yes.
    I feel we should point out the difference between Roth and Non-Roth IRAs and 401(k)s. It's probably accurate to say OP should contribute to a Roth IRA after maximizing his match in the 401(k), but he might want to go the Traditional IRA route instead, depending on his current tax situation and his prediction about his income in retirement and income tax rates at that time.
    Going with the Roth, you are locking in your current marginal tax rate on that income, so if it would have been higher in the future, you come out ahead. On the other hand, if you go the Traditional route, the tax break comes all at the top marginal rate, whereas the tax break from the Roth (that you get when you withdraw in retirement) is applied across all the tax rates, so it's effect is somewhat diminished.
    [–]Thisismyredditusern 1 point  ago
    That is a very concise summary of the Traditional versus Roth debate. Well done.
    [–]KhabaLox 1 point  ago
    I left out the part about flexibility with respect to taxable income in retirement. One of the advantages of having a Roth account is that you can pull money out of it and reduce your Traditional withdrawal if you get some sort of windfall income.
    [–]aurochal 2 points  ago
    So if I get a position in the federal government, should I fund my TSP completely before my Roth IRA? I read a lot about how great the TSP is for its low expense ratio funds. Wouldn't it make sense to decrease my taxable income as much as possible to get the most benefit out of contributing to a Roth IRA i.e. paying lower marginal taxes now for tax-free returns?
    [–]Dre_wj 1 point  ago
    TSP is one of the lowest expense retirement vehicles out there. Sleep well even if it is your sole account (outside of the FERS benefit and SS).
    [–]United StatesaBoglehead 1 point  ago
    The TSP has a Roth option, and yes - I would (and do) fund the TSP up to the annual limit before putting money towards an IRA.
    [–]duhhhh 6 points  ago
    The reason is tax diversification in retirement.
    With a Roth withdrawls are not counted as income. If you need to buy a car with retirement assets you can withdraw that money from a Roth without pushing you into a higher tax bracket. Also social security income is taxed if your other income exceeds certain threshholds. Traditional IRA/401k withdrawls count as income.
    [–]Zagor64 2 points  ago
    As /u/Boglehead said, you have total control over an IRA (where to open it, what funds you want to invest in etc.) while in the 401k you are basically stuck with what ever is there and it is usually not very good. The only downside to an IRA is the max limit. You can only contribute up to $5500 a year while you can contribute up to $17500 in the 401k.
    [–]United Statespentium4borg 2 points  ago
    After reading a lot on this subreddit, it seems like most people recommend contributing up the matched percentage, and then putting some into a Roth IRA. Is this accurate? Why is this a better option than contributing a larger amount to a 401k?
    Yes, you get more control over your investments (and the cost of those investments) in an IRA compared to a 401(k). But if you have more money to invest than maxing out your IRA and what's required to get your 401(k) match, you should then allocate that extra money to your 401(k) as well.
    [–]DrovemyChevytothe 2 points  ago
    It depends on how much you can afford to contribute. If you can do the 10% into your 401k, plus the full Roth IRA contributions each year ($5500 for both you and your wife), then great, don't change your 401k amount.
    But Roth IRA is a better deal and cheaper than 401k, after you reach the free money from the employer match.
    [–]nullsetcharacter 1 point  ago
    At your income you should be maxing the 401k and maxing the IRA every year.
    [–]Fantom1107 1 point  ago
    Maxing both his 401k and IRA would be 38% of his income. That's a bit excessive.
    [–]nullsetcharacter 0 points  ago
    It isn't excessive at all. I save more than 38% of my income, maxing out all retirement vehicles and then saving some extra in taxable accounts. It really isn't a problem if you know how to not waste money on dumb stupid shit that normal people seem to always want to buy. Excessive would be 80% of one's income, but 38% is actually a pretty good number to save.
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