Should I reach the maximum contribution to my 401(k) account or continue to grow my short term investments?
My wife and I are in our late twenties. We have both maxed out our Roth IRAs. I'm currently contributing 3% of my salary towards my 401(k) with no match. When I retire, I will collect a pension and 99% of my salary. I feel comfortable about my retirement plan: a full lump sum pension, a salary of $7,500, and a maxed out Roth account with 25 years of contributions. I also have an emergency fund. Should I work towards increasing my 401(k) contributions until I reach the maximum (to limit my taxable income)? Or should I continue to grow my short term investments? Or is a combination of both recommended?
Great work being so on top of your retirement plan! It’s great you have such a clear idea of what your future would look like. Without knowing more information, I think that splitting your extra cash between short term and long term investments is a good idea. You clearly have a plan for your career, but it would be a good idea to continue to contribute to your 401(k), at least as a back-up plan. If, for whatever reason, you didn’t have the pension at retirement, you’d want the extra money in your 401(k). that being said, this is a great time to achieve some of your shorter term financial goals. I would encourage you to consider how you invest and make sure all of the “extra” money you have is going into good investments that will grow and ultimately create some passive income for you. You’re on your way to financial independence, but you’ll need to be sure your putting your money toward things that will continue to appreciate in the long term.
It's great that you've begun to think long-term about your financial security. The earlier the better!
In regards to your pension, that's great you've found a company you want to work for until retirement. However, a lot can change between now and when you retire. It sounds like you have the mindset to save and invest and not necessarily only rely on your pension which is great. Keep in mind Roth contributions can only occur up until a certain income limit. There are a few other options if you want to keep contributing to an after-tax account like a Roth. Your employer may offer a Roth 401(k), which you'd be able to contribute all the way up to 18.5k in 2018. You could also look into a "backdoor roth" strategy. I'm not sure when you'll cross the income limit, but those are two things to think about if you are nearing that decision and want to grow an after-tax account.
To answer your original question, it's hard to give a definitive answer without knowing what your short-term goals may be? Do you want to buy a home in the near future? If that's the case, growing your investments in a taxable account, or accumulating cash may be in your best interest. If your goal is to put more away for retirement, then certainly increasing your 401(k) contributions would be the way to go. As you suggest, working towards multiple financial goals is commonplace, and shouldn't be done linearly. You can save more in your 401(k) AND put away savings for shorter term goals. At that point, it just comes down to prioritizing.
This is a great question and congratulations on thinking about this so early on. You are certainly putting yourself in a position to be financially successfull.
There are a number of factors that go into your question and need to all be considered together. I think the fact that you have gotten off on the right foot is fantastic. Now I think you should consider to begin to assemble your financial team that will lead you into your 30's and beyond. This team should include a fiduciary advisor and tax professional at a minimum. Together they will be in a position to help you determine the cost benefit of putting more funds in your 401(k) pre-tax, vs building a taxable account for your shorter term investments. Keep in mind, if you do not need the deduction and your employer offers a Roth 401(k) option that could work too and allow you to put more away than the IRA.
Chances are it is not a one or the other scenario and putting extra monies in each will provide you witha benefit. I would hesitate advising you without knowing your entire situation, tax braket, total household income, assets and liabilities. Build your team and they will be in a great position to guide you.
One additional piece of advice, we all have ideas about where we are going to be in the future. Ideally it sounds like you have plans to retire with your current employer, but what if that does not happen. How does that effect your retirement plan? These are all scenarios that can be reviewed and discussed with your team. Best of luck with your planning and reaching your goals!
Congratulations on thinking about all this so much in advance. It seems like you have a good plan and are doing all the right things. The one caveat I would have is to make some allowance for things not going as planned- as they say ‘there are many a slip between the cup and the lip’. You are fairly young and retirement is possibly several decades away.
About your specific question about increasing your 401K contributions or grow your short term: you have set aside an emergency fund- that is good. Are there any other short terms cash needs you may have? For example buy a house that may need a down payment, any other purchases? Needless to say, for these things you want to build the funds outside your retirement account in relatively liquid and stable investment or you may end up paying penalties in addition to taxes. Anything over and above that you can contribute to your 401K. Since 401K plans are tax deferred, any contribution to it will reduce your after tax income by less than that amount. The ability to grow your money in a tax deferred manner is quite powerful that you should take advantage of.
I commend you on thinking seriously about your financial future at a relatively young age and would encourage you to work with a financial planner for optimal outcomes. I am confused by some aspects of your question. You say that at retirement you will collect 1. "a pension" and 2. "99% of your salary." I'm thinking the pension would take the form of monthly annuity payments, as traditional pensions do, and the 99% salary would be a lump sum. However, you then say that your retirement plan is a "lump sum pension," so are you thinking of buying the pension out? And a "salary of $7,500," but if you're retired, there is no salary. Is this the annuity payment? I suggest you clarify these things for yourself and an advisor may be able to help with that. Part of youir planning should include prospective cash flow during retirement, the disbursement stage.
More importantly, an advisor will be able to help put your numbers into perspecitve in light of the impact of inflation upon the purchasing power of these future dollars. In 25 years, the $7,500 will likely be worth only about one-half of what it is today. As will the value of the 99% of salary. I'm thinking that salary is somewhat modest if you qualify for Roth contributions, which have income limits beyond which you cannot contribute. Your assumption that you will continue to make Roth contributions, for 25 years, implies that you anticipate continued modest earnings. As an alternative to these limits, you might also inquire if your employer has a Roth 401(k), with higher 401(k) contribution limits, as an option.
In addition, I think of financial planning as more of a contingency plan of various "what ifs," rather than trying to button down perceived certainties. You need to plan as if the pension will not be there when you need it. This is the reality of many currently retired individuals. They thought they had a pension, and then they didn't. Therefore, you can see that your personal savings, whether it is in Roth IRAs, 401(k)s or after tax investments, needs to be much more aggressive. It is wonderful that you have an employer with which you feel secure, but the reality is that none of us have any control over whether the pension will be there, the job will be there, or that you will be able to remain there for as long as you intended.
It may help to think of all investments as long-term and make that a priority. Such long-term investments can be through tax advantaged retirement vehicles, or simply after-tax individual or joint accounts. And yes, I do recommend a combinatin of both tax advantaged retirement and after-tax long-term investing. Aside from that, if you have short-term savings needs, perhaps for an upcoming major purchase, it would be best to simply save the money in a money market, rather than take on the risk of investing it and suffer a market fluctuation at the time you need the funds. Such short-term savings will be driven by whatever needs you identify.
I hope this has been helpful and wish you the very best going forward. Be sure to work with a fee-only fiduciary advisor.