Should I contribute to both my 401(k) and Roth IRA, or just focus on my IRA?
My employer offers a 50% 401(k) match, up to 3% of a minimum 6% pre-tax contribution from the employee (total 18% per month in savings, pre-tax, including the match). I can get within a couple hundred dollars of maximizing my Roth IRA contributions ($5,500/year). I contribute the minimum required to get the maximum match, and maximize contributions monthly to my Roth IRA. Given the fees for the 401(k), (I pay 0.04% for my Roth IRA) and its performance, which at best matches the S&P 500, does it make sense to still contribute to both? Or should I just focus on my IRA and use the extra cash in my paycheck to do other things (build savings, pay debt, invest elsewhere, etc.)?
Great question, and congrats on doing a great job in saving for retirement. I would continue to at least contribute the 6% to your company's 401(k) to receive the match. The match is free money, and I can't think of a situation where that would not be the right thing to do. After that, you can max out your Roth IRA account. At a recent JP Morgan Conference we discussed this exact topic, so here is the typical priority that I suggest to clients:
- Emergency account (3-6 months of living expenses)
- 401(k) savings to maximize employer match
- Additional payments on higher interest loans (i.e. credit card debt/student loans with interest > 6%)
- Health Savings Account (if eligible)
- Additional 401(k) savings up to the maximum contribution
- Additional payments on lower interest loans (i.e. student loans with interest < 6%)
- IRA contributions (if eligible)
- Taxable accounts
Since you are concerned about high fees in your 401(k) then in step 5 replace that with maxing out your Roth IRA. I think the step most often skipped is #4 with the health savings account, but these really can be beneficial. Hope this was helpful, good luck to you!
I hear your dilemma! When you consider all financial matters (pre-tax saving, matching, bills to pay, tax to set aside…), what was originally a simple goal--saving for retirement--suddenly becomes very complicated. Consequently, you become paralyzed and hesitant to make any decisions.
Fear not! Here’re the simple rules of thumb: 1) If work provides a matching in a retirement account, please make the most of it. It is the free money for you, why not? 2) Next, max out your own IRA (Roth or Traditional). You’re counting on the principal of time value of the money in this instance. 3) Do an HSA (health savings account) if you have a high deductible health insurance. Not only you can deduct it, but you can also invest it. Don’t use it now as you still have earned income to meet all medical expenses. Use the HSA as your future retirement healthcare fund when you don’t have any earnings besides the social security, if it still exists. 4)Tackle debts. Yes, you save for yourself first before tackling debts unless you have a very unreasonable high interest rate.
If you still have confusion or questions over those rules, talk to a CFP®. All of my colleagues, myself included, can definitely help you build a budget and guide you to pay down debts and build the retirement fund. Best!
As most advisors will tell you, you should contribute at least as much to your 401K as to take advantage of your company match- that is free money and you are essentially getting an instantaneous 100% return on investment. Beyond that, I would recommend paying off any high interest debt (For example credit card debts that can have interest rates as high as 25% compounded daily!).
I would next recommend taking care of other things like an emergency cash fund with 6-12 months of expenses depending on your job stability and family situation. Any funds that maybe needed in the short term such as for a down payment for a house should be invested conservatively and in a taxable account so that it is available for use without restrictions.
Beyond that, the excess cash that you have should be invested for the long term. When investing people often fall into the trap of mental accounting ie treating different investment buckets differently- for example I have seen some people take more risk in their retirement account than in their taxable account. The optimal way to invest should be based on your risk return profile and should apply to all your invetsmen accounts. As such,the tax benefits of your 401K is a very powerful tool that I recommend you should take advantage of.
You mention that you are dis-satisfied with your 401K returns - within the investment choices that your 401K plan provides, you should be able to change your asset allocation. Further, depending on your salary level you may also be able to make a contribution to a traditional IRA which would have a similar tax benefit as a 401K but will have more in investment choices.