Author Topic: General 401k Questions  (Read 5699 times)

Plebia

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General 401k Questions
« on: January 13, 2015, 05:33:39 PM »
Hi everyone! Brand spanking new Mustachian here, with a few questions that probably seem silly and basic but I would really appreciate some clarity. For reference, I have always been good at saving money but had no idea how investing worked at ALL until recently. So be gentle please :-)

I am a 24-year old looking into my best options for where to put my money. I have no credit card debt (woo!) and I am currently focusing on paying off student loan debt. I hope to have that completed within the year.  Once that is done, I plan to throw as much as possible into investing.

My employer offers a 401k plan with no match, which I currently put a negligible amount into (as I said, focusing on student loans). It is through Transamerica, and the performance for 2014 was as follows:

Contribution: $896.55
Fees: $1.30
Returns: $24.74

My question is 2-part: in all of your experience, is this a good place to throw as much extra cash into as I can? Secondly, what alternatives do I even have? I looked into IRAs and it seems you can only contribute $5500/year.

So, once my income is freed up and I can start growing a serious 'stash, where should it grow?

Thank you!

thedayisbrave

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Re: General 401k Questions
« Reply #1 on: January 13, 2015, 05:46:16 PM »
What funds are available through your 401k? Generally when deciding on which fund, it's best to focus on what you can control (costs/expense ratio) rather than on what you can't (returns).

Some more info is needed.  What's your salary and tax bracket? What's the balance on your student loan and what is the interest rate? If the interest rate on your SL is high, it's recommended to throw all extra toward that.  If it's 3% or under, a hybrid strategy (paying a little extra and investing) would be better.  In your case, you don't have an employer match so you're not giving up free money by not contributing to the 401k, but it's still tax-deferred space you won't get back once the year ends.

At your young age, I would look at also contributing to a Roth IRA (post tax, any money grows tax free).  This is generally recommended for those in a lower tax bracket, meaning people who are just starting their careers and have a lower income that is expected to increase as they continue working.  $5,500/yr is nothing to sneeze at, so you should be maxing that after maxing your 401k if possible.  This is valuable tax advantaged space - which is why there are limits imposed. 

MDM

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Re: General 401k Questions
« Reply #2 on: January 13, 2015, 05:48:24 PM »
Plebia, welcome to the forums.

Yes, for someone your age the IRA contribution limit is only $5500.  So you are doing well to ask about other options.

The 401k has an $18,000 limit so that is likely your best bet.  HSAs, if available to you, can also be good.  See http://www.madfientist.com/retire-even-earlier/ and associated links for some ideas.

You likely (maybe not, but likely) have various options within your 401k plan.  Can you copy/paste or transcribe the funds available, and the expense ratio for each?  You'll get much better responses if so.  Lacking that information, the generic advice would be "invest in the lowest fee broad stock index fund available" in the 401k.

Good luck!

dandarc

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Re: General 401k Questions
« Reply #3 on: January 13, 2015, 06:18:48 PM »
In your case, the 401K and the traditional IRA are pretty much equivalent - if you are happy with the options in your 401K, put money there, if not, fund the IRA first.  And of course make your Roth vs. Traditional decision on both (if employer offers Roth 401K) depending on your income.

+1 to MDM's HSA suggestion - if you have an HSA available, particularly if you can fund it through payroll, this might be the best first choice if it has decent investment options.

In a perfect world, and if you can, max out all 3 - 401K, HSA, IRA.

JLee

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Re: General 401k Questions
« Reply #4 on: January 13, 2015, 08:18:28 PM »
In your case, the 401K and the traditional IRA are pretty much equivalent - if you are happy with the options in your 401K, put money there, if not, fund the IRA first.  And of course make your Roth vs. Traditional decision on both (if employer offers Roth 401K) depending on your income.

+1 to MDM's HSA suggestion - if you have an HSA available, particularly if you can fund it through payroll, this might be the best first choice if it has decent investment options.

In a perfect world, and if you can, max out all 3 - 401K, HSA, IRA.

How do you make that decision (Roth vs Traditional)?  I just ran a calculator online and everything showed higher returns with Roth...not sure what I'm doing wrong.

Plebia

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Re: General 401k Questions
« Reply #5 on: January 13, 2015, 08:33:28 PM »
Hi all!

Thanks very much for the responses :-) To give some more information:

My annual salary is $35,000 which I also supplement with bartending on the weekends. I tend not to even try to put a number on that income, as it fluctuates wildly, and just use that as "bonus" to throw at the student loan.

My loans are:
Subsidized Stafford $2,180.81 3.400%
Unsubsidized Stafford $4,232.69 6.800%
Subsidized Stafford $4,879.91 3.400%
Unsubsidized Stafford $1,591.64 6.800%

As recommended above I have been paying down the principal on the two 6.8% loans first, and right now am making $675/month payments. Once those are paid off I plan to concentrate on investing.

Thanks for the HSA suggestion and the link, I had never heard of them!

On my current salary I don't think I'll be able to max out all three, although I suppose you should never say never :-)

The current 401k is a Vanguard Target Retirement Account, but through Transamerica. I would need to do some more digging for precise numbers, but I did peruse the options at the time I signed up and that one made the most sense to me, with the lowest cost.

Thanks to everyone who responded, this was very useful to confirm that my basic self-teaching about investment is, mostly, heading in the right direction. :-)

dandarc

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Re: General 401k Questions
« Reply #6 on: January 14, 2015, 08:23:39 AM »
Agree 100% with prioritizing the 6.8% loans.  Do you have any other debts?

I like Vanguard's Target date funds - have some money in there ourselves.

Real basic on the Roth / Traditional call - if you think your EFFECTIVE tax rate in retirement will be higher in retirement than your MARGINAL tax rate is today, you should go Roth.  If you think it will be reverse that, go traditional.  Your income likely puts you in the 15% federal income tax bracket (assuming filing single) - a lot of people draw the line between the 15% bracket and 25%.  If you're really committed to the frugality aspect of MMM for the long term, you might consider going traditional even in the 15% or 10% bracket.  http://www.gocurrycracker.com/never-pay-taxes-again/  If your taxable income is 0, then Roth is clearly the way to go.

Also consider state taxes - if you've got a state income tax, your marginal tax rate is higher.  If you're going to retire to a no-income tax state (Florida, Texas, Washington off the top of my head - there are probably more) but you're going to build your 'stache in a state with an income tax, that situation favors Traditional.

Any way,  the fact that you're seriously thinking about this stuff at 24 bodes well for the future - best of luck!

Plebia

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Re: General 401k Questions
« Reply #7 on: January 14, 2015, 11:41:10 AM »
Thanks for the reply, Dandarc. That definitely cleared up a few things!

No, I do not have any other debt. Credit cards are paid in full each month and I don't own a car, since I live 6 blocks from work. Wish zip car or something similar was offered around here, but that's another topic.

The traditional/Roth question is hard for me since I have no idea what my tax situation will be in the coming years, especially as I'm currently single but hope that won't always be the case :-)

Regardless, I'm currently working on upping my savings rate to 50℅ and we'll see where I can go from there.

Thanks again!

frugaliknowit

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Re: General 401k Questions
« Reply #8 on: January 14, 2015, 11:51:36 AM »
Besides what others have said, I would definitely fill the IRA (sounds like you are in a fairly low tax bracket, so likely Roth is a good tax bet...) before contributing to the 401K.  More choices, more control.  Good luck!!

ShoulderThingThatGoesUp

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Re: General 401k Questions
« Reply #9 on: January 14, 2015, 11:58:44 AM »
If you're able to max out your 401k you'll have a tiny taxable income (I'm assuming here that not all your bartending money goes through the formal banking system/withholding, no need to comment on that) so Roth would be the more reasonable IRA.

Plebia

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Re: General 401k Questions
« Reply #10 on: January 14, 2015, 12:08:16 PM »
I'm such a newbie, I never even considered that increasing my 401k contribution will decrease my taxable income! So how will that affect me when I go to file my taxes? My mind just exploded a little...

dandarc

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Re: General 401k Questions
« Reply #11 on: January 14, 2015, 12:13:14 PM »
Real basic here, and keep in mind that you may have a Roth 401K at your disposal as well, but assuming Traditional 401K:

No 401K contribution
Gross 35K
Standard Deduction / Personal Exemption = $10,300
Taxable Income = 24,700
Income tax = 3243.75

Maxed 401K contribution:
Gross 35K
401K 18K
Standard Deduction / Personal Exemption = 10,300
Taxable Income = 6700
Income tax = 670

MDM

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Re: General 401k Questions
« Reply #12 on: January 14, 2015, 12:15:25 PM »
I'm such a newbie, I never even considered that increasing my 401k contribution will decrease my taxable income! So how will that affect me when I go to file my taxes? My mind just exploded a little...
The W-2 you receive from your employer will show wages lower by the amount of the 401k.  After you enter the W-2 wages, you fill out the rest of the 1040 the same way you always have.  Assuming, that is, you have filled out 1040s before...?

dandarc

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Re: General 401k Questions
« Reply #13 on: January 14, 2015, 12:20:00 PM »
And just for kicks and giggles:

Maxed 401K contribution & traditional IRA:
Gross 35K
401K 18K
IRA 5.5K
Standard Deduction / Personal Exemption = 10,300
Taxable Income = 2200
Income tax = 220

One thing this doesn't take into account is the saver's tax credit.  If your AGI (Gross - 401K - IRA) is under 18K,  you get 50% back on up to 2K in retirement contributions, so that's up to 1K.  A more idealized savings plan might have your taxes like so:

Maxed 401K contribution & traditional IRA:
Gross 35K
401K 17K
Standard Deduction / Personal Exemption = 10,300
Taxable Income = 7700
Income tax = 770
Saver's Tax credit = 770
Final Income tax = 0


Then any additional savings should go into Roth (ignoring state income tax considerations).

ShoulderThingThatGoesUp

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Re: General 401k Questions
« Reply #14 on: January 14, 2015, 12:34:53 PM »
One thing this doesn't take into account is the saver's tax credit.  If your AGI (Gross - 401K - IRA) is under 18K,  you get 50% back on up to 2K in retirement contributions, so that's up to 1K.  A more idealized savings plan might have your taxes like so:

Whoa, didn't know about this. Looks like these double for married couples, so I think we might be in this camp this year. Sweet!

Plebia

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Re: General 401k Questions
« Reply #15 on: January 14, 2015, 12:38:00 PM »
As of tax time last year, I was 23, less than a year out of college, and had been employed full time with a 401k for only a few months. And I barely knew what a 401k was. And I was still a dependent on my parent's taxes. So while I have definitely filed taxes before, it was a lot different. Told you I was brand spanking new :-)

Thanks so much to everyone for all the food for thought!

dandarc

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Re: General 401k Questions
« Reply #16 on: January 14, 2015, 12:46:27 PM »
As of tax time last year, I was 23, less than a year out of college, and had been employed full time with a 401k for only a few months. And I barely knew what a 401k was. And I was still a dependent on my parent's taxes. So while I have definitely filed taxes before, it was a lot different. Told you I was brand spanking new :-)

Thanks so much to everyone for all the food for thought!
Learning to prepare your own taxes is good - the instructions for 1040 identifies a bunch of these things.  Tax planning is where you really save on the taxes - so deciding on things like "I'm going to put XXX into the 401K in 2015" and then following through.  So learning the details and then tailoring your plan to your situation.

I personally find tax optimization to be low-hanging fruit, but then I'm 34 and only really started doing it right in the last couple of years - if you figure this stuff out reasonably well and make it a part of your plan at 24 or 25, you'll be in really good shape going forward.

MDM

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Re: General 401k Questions
« Reply #17 on: January 14, 2015, 12:47:23 PM »
And just for [more] kicks and giggles:

CategoryMonthly amt.CommentsAnnual
Salary/Wages$2,917$35,000
401(k) / 403(b) / TSP / etc.$690Room to increase?$8,285
Income subject to IRS tax$2,226$26,715
Federal Adj. Gross Inc.$2,226$26,715
Federal tax$2015 rates, stand. ded., 1 exemption$1
State/City tax$111Guess, using 5.00% * Fed. AGI$1,336
Soc. Sec.$181Assumes 1 earner paying$2,170
Medicare$42$507
Total income taxes$335$4,020

In other words, contributing $8285 to the traditional 401k is enough to get you to ~$0 in federal income tax.  Any further contributions (401k or IRA) should definitely go into a Roth option.  Depending on your crystal ball for future earnings, going all Roth now could be defensible.

You can download the spreadsheet from http://forum.mrmoneymustache.com/ask-a-mustachian/how-to-write-a-%27case-study%27-topic/msg274228/#msg274228 and play "what if?" to your heart's content.

dandarc

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Re: General 401k Questions
« Reply #18 on: January 14, 2015, 01:03:22 PM »
And just for [more] kicks and giggles:

CategoryMonthly amt.CommentsAnnual
Salary/Wages$2,917$35,000
401(k) / 403(b) / TSP / etc.$690Room to increase?$8,285
Income subject to IRS tax$2,226$26,715
Federal Adj. Gross Inc.$2,226$26,715
Federal tax$2015 rates, stand. ded., 1 exemption$1
State/City tax$111Guess, using 5.00% * Fed. AGI$1,336
Soc. Sec.$181Assumes 1 earner paying$2,170
Medicare$42$507
Total income taxes$335$4,020

In other words, contributing $8285 to the traditional 401k is enough to get you to ~$0 in federal income tax.  Any further contributions (401k or IRA) should definitely go into a Roth option.  Depending on your crystal ball for future earnings, going all Roth now could be defensible.

You can download the spreadsheet from http://forum.mrmoneymustache.com/ask-a-mustachian/how-to-write-a-%27case-study%27-topic/msg274228/#msg274228 and play "what if?" to your heart's content.
Saver's Credit is wrong for a single person in the spreadsheet - cap is $1,000.  I see the $4,000 cap hard-coded in there - should be something like $2,000 X min(Number of earners, 2) I think.  Fantastic spreadsheet - might look into using that instead of my 'tax estimator' in my personal collection.

MDM

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Re: General 401k Questions
« Reply #19 on: January 14, 2015, 01:28:28 PM »
Saver's Credit is wrong for a single person in the spreadsheet - cap is $1,000.  I see the $4,000 cap hard-coded in there - should be something like $2,000 X min(Number of earners, 2) I think.  Fantastic spreadsheet - might look into using that instead of my 'tax estimator' in my personal collection.
Thanks - always nice to have great beta testers!  And there were a couple other things now fixed also (just saw your PM and you caught one of them too - well spotted!)

New version on Google Drive and output shown below:

CategoryMonthly amt.CommentsAnnual
Salary/Wages$2,917$35,000
401(k) / 403(b) / TSP / etc.$1,417Room to increase?$17,000
Income subject to IRS tax$1,500$18,000
Federal Adj. Gross Inc.$1,500$18,000
State/City tax$75Guess, using 5.00% * Fed. AGI$900
Soc. Sec.$181Assumes 1 earner paying$2,170
Medicare$42$507
Total income taxes$298$3,576