Author Topic: How much to contribute to 401k?  (Read 3612 times)

frugalNYC

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How much to contribute to 401k?
« on: June 22, 2015, 04:18:29 PM »
Hi Mustachians,

I'm starting a new job tomorrow and was just reviewing the 401k options online. Employer matches up to 5%, so I'm going to put in at least that. However, I should also say that I've never had a 401k before and have absolutely no retirement savings. I'm 29 and feel like I need to catch-up. But I'm also still working on knocking out my student loans ($14k left at 4.5%). Am on track to kill the loans by the end of the year if I don't put more than 5% into 401k. But maybe it's psychologically/strategically better for me to have a higher 401k contribution right off the bat?

Would appreciate your thoughts.

expectopatronum

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Re: How much to contribute to 401k?
« Reply #1 on: June 22, 2015, 04:49:30 PM »
Well, it's a personal decision since some are very debt-averse. I'm sure someone will come along with a more technical understanding, but 4.5% ain't bad for a loan rate when compared to 5-7% that it could make in the market AND the tax break it would get you immediately. So - maths will usually say that you're better off investing that, though don't forget about fees...

I'd consider your income, too. If you make $$$, the reduction in taxable income could be more worth it to you than paying off a small-ish loan. Then again, you're probably only making 6 mos your annual salary...whereas next year you'll make 100% of it.

You could also split the difference.

Frankies Girl

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Re: How much to contribute to 401k?
« Reply #2 on: June 22, 2015, 04:52:22 PM »
Congrats on the new job!

Definitely do up to the match. If you are sure you'll get the rest of your loans paid off by the end of the year, I personally would just set the 401k to the match, pay off everything and then switch over to hitting the next savings/investing bucket (see below).

The order to follow is (I believe):

401k/403b up to match
HSA to max - if available (isn't always, depends on the company)
Roth/Traditional IRA (depends on which works best for you) to max
401k to max
taxable brokerage

You'll want to review your investment choices ASAP, and select the option that has the lowest expense ratio and is closest to a broad market index fund. You can always post your entire list of available funds on here and folks will pick through them for you to try to explain what your best options would be for your situation. But make sure to post the name, ticker (the letters like VTSAX) and the expense ratios, and also what your investment goals are when you do, as you'll get a better response while at the same time you'll also get some practice looking at that stuff closely (at least closer than most people ever do!).


MDM

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Re: How much to contribute to 401k?
« Reply #3 on: June 22, 2015, 07:03:21 PM »
Employer matches up to 5%, so I'm going to put in at least that. However, I should also say that I've never had a 401k before and have absolutely no retirement savings. I'm 29 and feel like I need to catch-up. But I'm also still working on knocking out my student loans ($14k left at 4.5%). Am on track to kill the loans by the end of the year if I don't put more than 5% into 401k. But maybe it's psychologically/strategically better for me to have a higher 401k contribution right off the bat?

Would appreciate your thoughts.

One thought: you can pay the loan "any time," but you can make your 2015 401k contribution "this year only."  As others have noted the interest rate isn't awful.  I'd pay the minimum on the loans until hitting the maximum on both the 401k and whichever (trad or Roth) IRA, then flip a coin between paying the loans and investing taxably.  Of course, reasonable folks may differ.

ShoulderThingThatGoesUp

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Re: How much to contribute to 401k?
« Reply #4 on: June 22, 2015, 07:37:27 PM »
At 4.5% I think that maxing 401k is the right move.

MVal

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Re: How much to contribute to 401k?
« Reply #5 on: June 22, 2015, 08:47:26 PM »
I've wondered about this too. I am making $40K this year and I've just been contributing up to my employer's 5% match also. I paid my loans off last year and I'm maxing out my HSA this year. I had this goal for myself to do the max $5500 to the IRA this year, and to also amass an after-tax savings pile of $10,000. However, after doing more reading here and on Madfientist, I've come to realize maxing the 401K is a smart strategy.

But what is more important if you're in a low tax bracket like I am? Maxing out the 401K or maxing out the Roth IRA? Not sure what kind of raise I'll get next year, but I highly doubt I can afford to max out both. Which should be the priority?

MDM

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Re: How much to contribute to 401k?
« Reply #6 on: June 22, 2015, 10:58:03 PM »
I've wondered about this too. I am making $40K this year and I've just been contributing up to my employer's 5% match also. I paid my loans off last year and I'm maxing out my HSA this year. I had this goal for myself to do the max $5500 to the IRA this year, and to also amass an after-tax savings pile of $10,000. However, after doing more reading here and on Madfientist, I've come to realize maxing the 401K is a smart strategy.

But what is more important if you're in a low tax bracket like I am? Maxing out the 401K or maxing out the Roth IRA? Not sure what kind of raise I'll get next year, but I highly doubt I can afford to max out both. Which should be the priority?

Great question.  It would be nice to have a definitive answer based on information knowable today, but that isn't the case.

Fortunately for anyone just starting, a likely-enough correct answer is "either one".  Some assumptions behind that answer below.  Note that "trad" refers to traditional IRA, 401k, etc., and "Roth" refers to Roth IRA, 401k, etc.
  1) at some point you will withdraw money from a trad that will be taxed at a marginal rate even lower than you pay today
  2) at some point you will withdraw money from a Roth that, had it been in a trad, would have been taxed at a marginal rate higher than you pay today

If you believe #1 is incorrect (e.g., if you will have other income from a pension, etc. so the trad withdrawals will always be taxed at 15% or more), skip the trad.
If you believe #2 is incorrect (e.g., if you expect never to be in a higher marginal bracket than you are now), skip the Roth.

Mirwen

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Re: How much to contribute to 401k?
« Reply #7 on: June 22, 2015, 11:26:12 PM »


But what is more important if you're in a low tax bracket like I am? Maxing out the 401K or maxing out the Roth IRA? Not sure what kind of raise I'll get next year, but I highly doubt I can afford to max out both. Which should be the priority?

That depends on how low income you are and what kind of credits you qualify for.  I have two kids and a gross family income of $40k.  I put $7k in tax advantaged accounts.  I used to do Roth, because hey, I'm in the 10% tax bracket, right? But no! I was wrong. Traditional gets me down to that magic number of around $34k where I get 50% savers credit.  I also get significantly increased EIC as well as lowering my IBR payments on my student loan along with my usual marginal tax savings.  I think at one point I calculated that I get back 54% in tax benefits from using the traditional accounts.  So depending on your situation you may want to use traditional, even if you are low income.

expectopatronum

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Re: How much to contribute to 401k?
« Reply #8 on: June 22, 2015, 11:34:41 PM »
I've wondered about this too. I am making $40K this year and I've just been contributing up to my employer's 5% match also. I paid my loans off last year and I'm maxing out my HSA this year. I had this goal for myself to do the max $5500 to the IRA this year, and to also amass an after-tax savings pile of $10,000. However, after doing more reading here and on Madfientist, I've come to realize maxing the 401K is a smart strategy.

But what is more important if you're in a low tax bracket like I am? Maxing out the 401K or maxing out the Roth IRA? Not sure what kind of raise I'll get next year, but I highly doubt I can afford to max out both. Which should be the priority?

A toss up, like MDM said. I'd personally max the Roth because the target of $5500 is doable and satisfying, then throw extra monies at the 401(k). That gives you a little of both benefits, and I like having taxes paid. Who knows what changes are coming in the next 30+ years. You've only just eked into the 25% bracket here. The mixed approach diversifies your fleet of investment vehicles, and for me that means less risk of peeing my pants anytime there's a change in tax code because it isn't likely to affect all my assets...just some. I tend to think the Roth is a great deal for someone making $40-50K or less based on the fact that I think our desired retirement income would be around that much or more. Only if it's less do I "lose" the trad vs Roth bet, and really since I'm withdrawing less money, I see it as a win...

A strict 401(k) approach means $18K towards it, and I'd be pretty impressed if you had leftover to put into a Roth beyond that.

The main thing is to save it one way or the other. : ) I think either is a valid approach.

MDM

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Re: How much to contribute to 401k?
« Reply #9 on: June 22, 2015, 11:42:50 PM »
So depending on your situation you may want to use traditional, even if you are low income.

A great point, and well worth remembering to check the immediate tax consequences.  As Mirwen says, they really can be significant, especially filing as a family with children.

teen persuasion

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Re: How much to contribute to 401k?
« Reply #10 on: June 23, 2015, 07:37:16 AM »


But what is more important if you're in a low tax bracket like I am? Maxing out the 401K or maxing out the Roth IRA? Not sure what kind of raise I'll get next year, but I highly doubt I can afford to max out both. Which should be the priority?

That depends on how low income you are and what kind of credits you qualify for.  I have two kids and a gross family income of $40k.  I put $7k in tax advantaged accounts.  I used to do Roth, because hey, I'm in the 10% tax bracket, right? But no! I was wrong. Traditional gets me down to that magic number of around $34k where I get 50% savers credit.  I also get significantly increased EIC as well as lowering my IBR payments on my student loan along with my usual marginal tax savings.  I think at one point I calculated that I get back 54% in tax benefits from using the traditional accounts.  So depending on your situation you may want to use traditional, even if you are low income.

Definitely depends on your details.  DH is maxing his HSA, and then putting as much as possible in his 401k (trad) to lower our AGI, which boosts our EITC.  EITC and CTC are partially matched on our state tax return, increasing our refunds again.  THEN I turn around and use the refunds to fund our Roth IRAs.  I do Roth IRAs rather than traditional, since we are at the point of zero fed tax (no savers credit for us, nonrefundable), and traditional IRAs would not alter our EITC any.  I've been looking ahead to how our taxes will change as the last of our kids head off to college and become independent.  I will need to change tracks at that point, but DS5 is only 10, so some time to plan yet.