Author Topic: Differing schools of thought: invest up to match, or max out?  (Read 7832 times)

EconDiva

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I have heard some say you should only invest the minimum in your 401k to get the match, then use the remaining funds to max a Roth IRA and then individual investments. Yet I've also heard people say to always max the 401k first.

Which is your preferred method and why?

warfreak2

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #1 on: March 27, 2014, 11:18:05 AM »
I think it depends on what funds are available through your company's 401k. I've heard that many don't offer a very good selection.

Eric

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #2 on: March 27, 2014, 11:25:57 AM »
Maxing your 401k reduces your tax bill by the most, so that would get my vote.

MDM

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #3 on: March 27, 2014, 11:32:24 AM »
Maxing your 401k reduces your tax bill by the most, so that would get my vote.
Agreed. 

With the possible exception...
I think it depends on what funds are available through your company's 401k. I've heard that many don't offer a very good selection.
...that you have truly terrible selections.

But the odds are I think in favor of the 401k.  So, speaking of school, do your homework on the 401k options available to you and go from there.

nereo

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #4 on: March 27, 2014, 11:34:48 AM »
Which is your preferred method and why?
It depends in part on what options are available for the 401(k). 
If the company offers a low-cost index fund, my preferred strategy is to
1)contribute enough to the 401(k) to get the full match, THEN
2) max out my IRA, THEN
3a) contribute (until I max out) my 401(k) OR
3b) divide my savings between post-tax savings and 401(k)

my reasoning: 401(k) match is like getting an huge automatic return, so I always do that first.
The IRA offers me a lot of freedom down the road, so I do that second.  I've been converting my tIRAs into ROTH IRAs lately.
Finally, whether I max out my 401(k) depends on how good the 401(k) options are and whether I have another savings goal to meet in the next 0-3 years (e.g. a down payment, or an expensive repair coming up).   Deciding between 3a & 3b requires me to calculate tax-savings vs upcoming expenses.
My goal is to always do all 3 - max out the IRA, max out the 401(k), and save even more money. Unfortunately I can't do that right now with my job.

skyrefuge

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #5 on: March 27, 2014, 11:39:09 AM »
The prototypical Mustachian should max out all their tax-deferred space while working, including their 401(k). This is due to The Lovely Low Taxes of Early Retirement. (also see this thread). Those taxes that you defer by contributing to your 401(k) have a good chance of never appearing.

There are some who might benefit from avoiding their 401(k) past the match, but that person has to fit all or most of these characteristics: 1) be someone who requires an income in retirement that nearly matches their working income (this could be someone with a very low working income, but in the wider world more likely represents a Consumer Sukka); 2) have a truly terrible 401(k) plan/expenses; 3) expect to work at that job for a really long time and thus never have the opportunity to roll the 401(k) into an IRA. That doesn't match a lot of people, particularly people posting at this forum.

The Mad Fientist shows (scroll down to Addendum I) the math revealing that even with ridiculous 401(k) expenses, it's still better for a low-expense retiree to max the 401(k), because the tax savings will outweigh the expenses.

The "standard advice" you mention in the first half of your post may very well make sense for "standard people", but we Mustachians are pretty far from standard, and thus, that advice doesn't generally apply to us.
« Last Edit: March 27, 2014, 11:41:21 AM by skyrefuge »

warfreak2

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #6 on: March 27, 2014, 11:48:24 AM »
I've heard that many don't offer a very good selection.
...that you have truly terrible selections.
Translation from British.

OneDogGP

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #7 on: March 27, 2014, 01:09:00 PM »
skyrefuge - I'm in a similar boat with the 401k / match / Roth and am wondering how in the heck is a working stiff able to put away any savings to hopefully reach that elusive status of being financially independent if all your "disposable" salary is going into maxing out the retirement accounts?  It's probably a dumb idea, but part of me wants to cut back on the 401k percentage just so my savings can grow faster so I can find other investments to replace my income so I can either get out of the rat race or at least retire earlier without having to tap investment accounts and pay penalties.

Sorry, frustrated.  Thanks for any advice. 

Eric

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #8 on: March 27, 2014, 01:29:25 PM »
skyrefuge - I'm in a similar boat with the 401k / match / Roth and am wondering how in the heck is a working stiff able to put away any savings to hopefully reach that elusive status of being financially independent if all your "disposable" salary is going into maxing out the retirement accounts?  It's probably a dumb idea, but part of me wants to cut back on the 401k percentage just so my savings can grow faster so I can find other investments to replace my income so I can either get out of the rat race or at least retire earlier without having to tap investment accounts and pay penalties.

Sorry, frustrated.  Thanks for any advice.

You won't increase your savings by cutting your 401k contribution.  You'll do the opposite.  Are you saying you're worried that money in your 401k is inaccessible without penalty until you're 59.5?  Well, that's just not true at all.

http://jlcollinsnh.com/2013/12/05/stocks-part-xx-early-retirement-withdrawal-strategies-and-roth-conversion-ladders-from-a-mad-fientist/

http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/

MDM

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #9 on: March 27, 2014, 01:32:48 PM »
OneDogGP,

Eric was quicker on the draw but as long as this was written anyway....

Yes, there often needs to be a trade-off between short term and long term gratification.

"how [can you] put away any savings...if all your "disposable" salary is going into maxing out the retirement accounts?"
You'll want a certain amount for an emergency fund, but otherwise the retirement accounts hold your savings.

"...find other investments to replace my income so I can...retire earlier without having to tap investment accounts and pay penalties."
See http://www.mrmoneymustache.com/forum/ask-a-mustachian/early-retirees-how-did-you-financially-transition-to-retiring for a few perspectives on this.

nawhite

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #10 on: March 27, 2014, 03:30:47 PM »
There was a long discussion of this topic here: http://www.mrmoneymustache.com/forum/investor-alley/why-do-people-say-to-max-roth-before-401k/

Basically came down to what skyrefuge said. For me, I absolutely should be maxing traditional 401k and traditional IRA before I even look at Roths or any other account (including most debt). But that's because I make a lot of money now and plan to make very little in about 5 years while I'll still be young. So I get to maximize the rollover to a roth and my taxes now are in the 25% marginal rate while I'll have an 8% effective rate in retirement. Much much much better deal to do traditional accounts to the max for me now.

Some of my friends who are in the 15% tax bracket now should probably do the 401k to match/then roth/then max 401k.

Vjklander

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #11 on: March 27, 2014, 07:16:23 PM »
There was a long discussion of this topic here: http://www.mrmoneymustache.com/forum/investor-alley/why-do-people-say-to-max-roth-before-401k/

Basically came down to what skyrefuge said. For me, I absolutely should be maxing traditional 401k and traditional IRA before I even look at Roths or any other account (including most debt). But that's because I make a lot of money now and plan to make very little in about 5 years while I'll still be young. So I get to maximize the rollover to a roth and my taxes now are in the 25% marginal rate while I'll have an 8% effective rate in retirement. Much much much better deal to do traditional accounts to the max for me now.

Some of my friends who are in the 15% tax bracket now should probably do the 401k to match/then roth/then max 401k.

I absolutely agree ... it all depends on the marginal tax rate.

teen persuasion

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #12 on: March 28, 2014, 07:41:15 AM »
Maxing the 401k at a lower marginal rate is useful, too. We max DH's 401k even without any match, to lower our taxable income to zero, and to increase our EITC, which our state matches at 30%. So every dollar we put in his 401k returns/saves 41.3%: 21% EITC phaseout, 6.3% state match, 10% fed tax, 4% state tax. Only thing better would be the HSA deductions, which also saves the 7.65% FICA.

Then we turn around and put the refunds in our Roths.

stuckinmn

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #13 on: March 28, 2014, 09:04:09 AM »
Depends entirely on your tax bracket and available funds.

Typically, i would do it in the following order of priority. So if you have enough to fill up only the first 2 that's what you do, if you can do all 4 great.

1.  401k up to match
2.  Roth, assuming you are eligible.  (If you make too much to be elgible for a Roth you should be knocking the heck out of 3 and 4 though as you have plenty of income)
3.  401k up to 17,500 max
4.  Taxable brokerage accounts

Of course if you are in the 0,10 or even 15% bracket after filling up the first 2, you might want to skip step 3 and go to 4 as you'll need some non-retirement cash while you work on accessing your retirements account (turn 59, create a roth pipeline or do a 72t election).   

 

soccerluvof4

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #14 on: March 28, 2014, 09:16:44 AM »
Maxing your 401k reduces your tax bill by the most, so that would get my vote.

^+1

Also HSA if you have one.

skyrefuge

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #15 on: March 28, 2014, 10:45:57 AM »
Typically, i would do it in the following order of priority.

Argh. This is like someone at a forum for 7 foot tall NBA centers asking "what size shoe should I get?", and getting the response "Typically, men wear size 10, so I would get that size." That shoe ain't likely to fit very well.

Could you at least explain the reasons why a Roth IRA investment is likely to be more valuable to a Mustachian than an unmatched Traditional 401(k) investment (or even a Roth 401(k) investment, since the OP didn't specify)?

If you make too much to be elgible for a Roth

No one makes too much income to be eligible for a Roth IRA: http://www.bogleheads.org/wiki/Backdoor_Roth_IRA

stuckinmn

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #16 on: March 28, 2014, 11:52:19 AM »
Well, sky, truthfully I didn't want to get into every nuance and was just keeping it general.  And the backdoor roth is a great deal, but is unavailable for many like me that have rollover IRAs since the conversion will be taxed pro-rata as a distribution from those rollover IRAs and I will get a tax hit on that.  Seems that many folks have these rollovers so I'm not sure the availability of backdoor roths is as widespread as often reported.

The only sure thing is that investing your 401k to the match is always your absolute #1 priority (aside of course from having enough to meet your basic mustachian needs like heat and food).  It is free money plus a tax break.  The next closest sure thing is to always do a roth before taxable, since if you are going to be investing after tax money, you might as well get a tax break out of it.  The only time this last one might not apply is if you need an after tax account you will need easy access to.   

So it comes down to 401k after match vs. Roth with only a few instances where the answer is clear.  If you are high income/high tax rate, I would do 2) 401k up to 17,500, 3) roth, 4) taxable. If your income tax rate is zero, then 2) roth, 3) taxable, and forget about any additional 401k.

If you are somewhere in between you have to make some guesses.  If your marginal income rate right now is higher now than you anticipate it will be in retirement, 401k is better than a Roth as you are effectively exchanging a high current rate for a lower future one.  If it is lower now than you think it will be in retirement, the Roth is the way to go as you are locking in low rates now.  there are of course other factors to consider like the fact that you can withdraw your contributions (but not gains) to a Roth after 5 years but the primary driver is probably tax efficiency, at least in my case.

The big problem is there no way to know what future tax rates will be.  It is highly likely, in my opinion, that tax rates will have to rise at some point to address the US budget problems.  However, as skyrefuge and many others have pointed out, a mustachian retirement will necessarily lead to a low income tax rate if a person is smart about it. 

Personally, if I can pay 10 or 15% tax on some income now and never have to pay on it again, I'd pay it now, just for the sake of certainty.  But at a 25% rate,  I'd rather take my chances and defer it to to the future.  Your analysis may vary.

 


 

 

Iron Mike Sharpe

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #17 on: March 28, 2014, 12:55:49 PM »
I work for a mega corporation with a good 401K plan.  I'm also in the 25% tax bracket. 


The best way for me to invest is:

1)  401K up to 4% to get the match
2)  max out HSA for the triple tax benefits
3)  go back to 401K and invest up to the company imposed 25% (I cannot get to the govt imposed $17,500 yet as I don't make enough)
4)  Roth IRA
5)  taxable

skyrefuge

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #18 on: March 28, 2014, 01:15:12 PM »
Thanks, stuckinmn, excellent post, I agree almost completely with it.

the backdoor roth is a great deal, but is unavailable for many like me that have rollover IRAs since the conversion will be taxed pro-rata as a distribution from those rollover IRAs and I will get a tax hit on that.  Seems that many folks have these rollovers so I'm not sure the availability of backdoor roths is as widespread as often reported.

Agreed, chances are the Backdoor Roth only makes sense for relatively young high-income workers, or older ones who had an epiphany and just started saving for retirement for the first time right now. But everyone is still eligible for it; whether it's a wise move or not is a separate question, and one that can only be asked if the person is aware the possibility exists. And note that those two types of people (or at least the first), while they might be rare, are likely to be overrepresented among Mustachians vs. the general population.

If you are somewhere in between you have to make some guesses.

Yeah, so my point is that the probabilities are significantly different for Mustachians than they are for the general population, so we should avoid simply repeating that generalized advice. Some of the unknowns become much more known for Mustachians.

The shock and excitement generated by the tax bill of ZERO thread indicates that even among Mustachians, there are many who still don't truly grasp how low our future taxes will be. GoCurryCracker didn't really do anything super-innovative or tricky to get that zero tax bill; most post-retirement Mustachians would achieve the same, by simply falling into it due to the circumstances they set up that allowed their early retirement.
 
So I think we need to take every opportunity we can to show the places where "conventional wisdom" is not particularly applicable to Mustachians. I'm not saying that there won't be any Mustachians for whom the conventional wisdom ends up being the optimal choice, but I think that in this case we should not use the conventional wisdom as the default advice.

The big problem is there no way to know what future tax rates will be.  It is highly likely, in my opinion, that tax rates will have to rise at some point to address the US budget problems.

I agree that general tax rates are likely to rise. However, I see two mitigating factors for Mustachians:

1) It seems much more likely that the increases would hit middle and upper-income people; tax increases on the "poor" are neither very popular nor that great at generating revenue.
2) The retirement time horizon for Mustachians is probably on the order of a decade, not 3 or 4 decades; the uncertainty of future rates becomes more certain when the future isn't as far away.

Personally, if I can pay 10 or 15% tax on some income now and never have to pay on it again, I'd pay it now, just for the sake of certainty.  But at a 25% rate,  I'd rather take my chances and defer it to to the future.  Your analysis may vary.

With my current numbers, it would take a pretty giant change in tax laws for me to end up paying a 15% effective rate in retirement (heck, I pay less than 20% now, when my income is 4x higher!); I'd still make the bet to defer even at a 10% current marginal rate. "Zero" is just so much smaller than anything that's not zero.

stuckinmn

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #19 on: March 28, 2014, 03:01:58 PM »
Fair point on the lower tax rate in mustachian retirement but I do want to point out that the majority of GoCurry's income came from capital gains and qualified dividends which qualify for 0% treatment up to to 72K or so of AGI.   

However, amounts in a 401K are going to be subject ordinary income on all amounts when it is finally taken out.  If you have a smaller 401K or traditional IRA and start the conversions/withdrawals early enough you might be able to avoid all of the income taxes by keeping withdrawals to your personal exemptions and standard deduction, but anyone with a larger 401K is likely going to have to pay some taxes on it at some point.

 I've managed to stash away quite a bit of my holdings in my 401k/traditional IRA so I know I  won't be getting it to 0 when I eventually pull it out. That's the reason I'd personally be willing to pay 15 % now to avoid taxes in the future but am willing to take my chances on the 25%.         

skyrefuge

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #20 on: March 28, 2014, 04:38:47 PM »
Fair point on the lower tax rate in mustachian retirement but I do want to point out that the majority of GoCurry's income came from capital gains and qualified dividends which qualify for 0% treatment up to to 72K or so of AGI.

Yeah, though most of that "income" wasn't actually income that they used for spending (a $92k/year burn rate would be spectacularly extravagant by Mustachian standards). It was simply money that they had the opportunity to "pay taxes on now" (at a 0% rate) and then not have to pay them later.

In the extreme case where a married couple's sole source of retirement income is their tax-deferred IRA/401(k), under current law they could withdraw and spend $75k per year and still pay less than 10% tax it. So you don't even have to be very Mustachian at all to get pretty low retirement tax rates. And in the case where that $75k is an unwanted RMD way above spending needs, then I say that person just saved way too much money before retiring, which is not a mistake I'd expect to see from budding Mustachians asking about investment advice.

For reference, a more Mustachian $30k yearly withdrawal results in a 3.3% tax rate.

But yes, it certainly would be a good idea to follow GoCurryCracker's example and maximize the amount of tax-deferred withdrawals/conversions and cost-basis resets as soon as possible, since you don't know how much longer you'll face 0% tax on those actions.

SDREMNGR

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #21 on: March 28, 2014, 06:14:38 PM »
I'll second the 1) 401k up to matching (if there is), 2) Roth IRA to max, 3) 401k to max 4) non-tax deferred investing (real estate is my choice, with most of my short term money also in stocks in a trading account)

But the bigger issue is if you aren't making enough money to max out both your 401k AND your Roth IRA AND have extra money left over to save and invest in other endeavors, you should first be focusing on increasing your income and decreasing your spendings. You can model and tweak the slight advantages and disadvantages of which account to invest in all day long but that isn't going to help you get greater wealth nearly as much as thinking and working on the actual ways you can make more money and save more money.

Roland of Gilead

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #22 on: March 28, 2014, 06:23:44 PM »
We not only max out our 401K (and do a backdoor Roth + HSA) but we contribute $20,000 more to our 401K using after tax money and then do a in plan conversion of that money to a Roth 401K.  This is sort of like a $20,000 a year backdoor Roth.   Great if your company offers this type of thing and you can afford to take the immediate income hit.


Joel

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #23 on: March 28, 2014, 06:36:04 PM »
Which is your preferred method and why?
It depends in part on what options are available for the 401(k). 
If the company offers a low-cost index fund, my preferred strategy is to
1)contribute enough to the 401(k) to get the full match, THEN
2) max out my IRA, THEN
3a) contribute (until I max out) my 401(k) OR
3b) divide my savings between post-tax savings and 401(k)

my reasoning: 401(k) match is like getting an huge automatic return, so I always do that first.
The IRA offers me a lot of freedom down the road, so I do that second.  I've been converting my tIRAs into ROTH IRAs lately.
Finally, whether I max out my 401(k) depends on how good the 401(k) options are and whether I have another savings goal to meet in the next 0-3 years (e.g. a down payment, or an expensive repair coming up).   Deciding between 3a & 3b requires me to calculate tax-savings vs upcoming expenses.
My goal is to always do all 3 - max out the IRA, max out the 401(k), and save even more money. Unfortunately I can't do that right now with my job.

This pretty much nailed it for me.

AccidentalMiser

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #24 on: March 28, 2014, 06:46:10 PM »
There was a long discussion of this topic here: http://www.mrmoneymustache.com/forum/investor-alley/why-do-people-say-to-max-roth-before-401k/

Basically came down to what skyrefuge said. For me, I absolutely should be maxing traditional 401k and traditional IRA before I even look at Roths or any other account (including most debt). But that's because I make a lot of money now and plan to make very little in about 5 years while I'll still be young. So I get to maximize the rollover to a roth and my taxes now are in the 25% marginal rate while I'll have an 8% effective rate in retirement. Much much much better deal to do traditional accounts to the max for me now.

Some of my friends who are in the 15% tax bracket now should probably do the 401k to match/then roth/then max 401k.

I absolutely agree ... it all depends on the marginal tax rate.

This.  It depends on your income, deductions, marital status, etc.  Generally, maxing out the 401k first is the smartest thing to do, but not always for younger people in lower tax brackets.

nawhite

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #25 on: March 28, 2014, 06:59:44 PM »
Ok here are 2 rules that apply to 95% of people:
1) 401k up to match (if the match is 1 to 1) SHOULD ALWAYS be first
2) Roth IRA SHOULD ALWAYS be before Taxable

As Accidental Miser pointed out, 1 isn't true for very young people who are currently in a very low tax bracket and expect to retire into a higher tax bracket a long time from now.
2 isn't true for people who are <5 years away from FIRE and don't have any other source of savings (including Roth IRA contributions) to tap while they prime the pump on a Roth pipeline or are waiting for 59.5.

All other things depend on your situation and any other advice is a rule of thumb. If you want the most correct answer, you should post a case study.

For me, a Traditional IRA will beat a Roth IRA hands down. I should absolutely not be contributing to a Roth given my situation. It would be a dumb idea comparatively. I know I'm in the minority in that case though. I don't go around telling people they should do that because it might not fit their situation. The two rules above are the only 2 that I can think of that even have a 95% chance of applying.
« Last Edit: March 28, 2014, 07:01:18 PM by nawhite »

ender

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #26 on: March 28, 2014, 10:59:00 PM »
This is my last year contributing to a Roth IRA until my tax situation changes - next year I will put the money into a traditional IRA to take advantage of the 33% tax savings it causes (8% state, 25% federal marginal rates).

Because I will keep the nearly $2k that saves going into some sort of savings (either house downpayment or taxable investments) it's easy for me to fully capture the tax savings.


EconDiva

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Re: Differing schools of thought: invest up to match, or max out?
« Reply #27 on: March 29, 2014, 08:44:22 AM »
I'll second the 1) 401k up to matching (if there is), 2) Roth IRA to max, 3) 401k to max 4) non-tax deferred investing (real estate is my choice, with most of my short term money also in stocks in a trading account)

But the bigger issue is if you aren't making enough money to max out both your 401k AND your Roth IRA AND have extra money left over to save and invest in other endeavors, you should first be focusing on increasing your income and decreasing your spendings. You can model and tweak the slight advantages and disadvantages of which account to invest in all day long but that isn't going to help you get greater wealth nearly as much as thinking and working on the actual ways you can make more money and save more money.

This is the order I'm going in right now. I make enough to do 1-3 but not 4. I'm doing 1 and 2 easily, and bumping up my contributions each month to get me to step 3 by August. I think getting to step 4 may be more feasible through bonuses, a second job, and/or promotions.