Should I increase my monthly percentage into my Roth 401(k) for the remainder of the year?
I've recently maxed out my Roth IRA at $5,500 for my 2018 contributions. I also contribute 6 percent with a 4 percent company match into my Roth 401(k). I am conflicted as to whether or not I should increase my monthly percentage into my Roth 401(k) for the remainder of the year. Alternatively, should I save the additional after-tax cash in a high interest savings account as a cushion to contribute and max out my 2019 Roth IRA contributions?
A Roth IRA and Roth 401(k) sound similar, and in many respects, they are. Contributions are made with after-tax money, and your earnings grow tax-free. When you reach age 59 ½, qualified withdrawals are not taxed. As the owner of the Roth IRA, you don’t need to take required minimum distributions. In determining which Roth is best for you for the remainder of the year and for your future goals, you should understand the differences between the two and decide based on your specific circumstances.
The maximum you can contribute to a Roth IRA for 2018 is $5,500 or $6,500 if you’re age 50 or older. A Roth IRA is also subject to an income limit. If you’re above that limit, you are not allowed to contribute to a Roth IRA. In a Roth 401(k), the income limit does not apply, however, there is a contribution limit. For 2018, the maximum contribution to a Roth 401(k) is $18,500 or $24,500 if you’re age 50 or older.
Investment options and fees:
In a Roth IRA, you have more investment options to choose from. You have access to a large variety of investments, from individual stocks, ETFs, bonds, mutual funds, REITs, commodities, etc. In a Roth 401(k) plan, you are limited to what the employer plan offers. You should also compare fees in your 401(k) options to similar investments you can get in a Roth IRA. Higher fees will undermine your return.
For the most part, an early withdrawal is when you take money out of a retirement account before you reach age 59 1/2. With a Roth IRA, you can withdrawal your after-tax contributions without penalty and taxes (you already paid taxes on these funds). According to the IRS distribution ordering rule, your non-taxable contributions are distributed before taxable earnings. In a Roth 401(k), the distributions are calculated on a pro-rata basis, which means the withdrawal amount is prorated between your original contribution and earnings. Your original contribution will not be tax and is penalty free. The earnings will be subject to the 10% penalty and will be taxed. It’s also important to note that not all 401(k) plans allow for early withdrawals, so you need to check with your 401(k) plan document.
Required Minimum Distributions (RMD):
Generally speaking, when you reach 70 ½, the IRS requires you to start taking withdrawals, know as required minimum distributions, or RMDs from your tax-deferred IRAs such as a traditional IRA, SIMPLE IRA, and SEP IRA. Roth IRAs do not require withdrawals until after the death of the owner. A Roth 401(k) does require you to take RMDs at 70 ½ unless you are still working for the company and not a 5% or greater owner. If you leave your employer, you can roll over your Roth 401(k) to a Roth IRA to avoid the RMD.
Keeping these differences in mind, you should not only think about where to put your money today or next year, but what fits you best for years to come.
When you can max out Roth 401k, it’s equivalent to enhance your future Roth IRA as all Roth 401k can be directly rolled over to the Roth IRA. Unless you’re an early Roth IRA contributor, I’d say go and max out this year’s $18,500 Roth 401k. Meanwhile, reviewing your budget to see if there’s any opportunity to save extra for 2019 Roth IRA.
I’m very pleased to see your dedication for saving, so I only have one extra tip to offer, which is to save up your emergency fund. It should be 12 months of living expenses for a single, or 6 months for a married couple. Once you have that extra cushion for contingencies, you are financially disciplined to stick to your saving plans and weather through any volatile stock market. Cheers!
It's impossible to appropriately answer your question without more information:
1. Your current tax bracket
2. Your age
3. Your expected retirement date
4. Your expected tax bracket(s), state and federal, on that date
5. Your marital status, spouse's age
6. If married, both your incomes, retirement contributions and balances.
Since these are tax-advantaged contributions and accounts, wouldn't the highest priority be to figure out which options provide the best tax benefits? Despite the fact that we're in some of the lowest tax brackets in history, and, that tax rates will have to go way up in 2026 what if you retire into a lower tax bracket than you're in now? You will have permanently taxed your retirement savings at a higher rate than you would have paid in retirement.
It would be well worth your while to hire an hourly fee planner to test different scenarios for you using software like RightCapital or RetirementAnalyzer. I suspect the recommended strategy will be a combination of pre-tax and after-tax contributions along with a brokerage account. Your questions cannot be answered yes or no!
There's certainly nothing wrong with putting more money aside in retirement accounts such as a Roth 401(k). If you have the means to increase your conributions for the rest of the year, while stockpiling cash in a high yield savings accounts until next year to max out your 2019 Roth IRA contributions, certainly do so.
Reasons you may consider investing in a taxable account or holding cash would be to satisfy shorter-term goals such as a home downpayment.
Great job on being so diligent and thorough in saving for your non-working years!
The general rule surrounding saving for retirement states every employee should save roughly between 10-15% of your income for retirement if you plan to retire at the normal age(roughly 65.) If however, you want to stop working early, that range bumps up to about 20-25% of your pay.
Here are two different choices:
- If you plan on doing everything possible to retire early, by all means go ahead and max out your Roth 401k and start saving for the 2019 Roth IRA contributions.
- If you plan on retiring at a normal age, you're doing everything you need to already. I would open a brokerage account and start saving/investing in that vehicle. You can contribute as much as you want, take out as much as you want and you'll just pay capital gains tax.
Hope this helps!