What is the ideal contribution to a 401k?

I contribute about 10% to my 401k. I want to know more about Roth IRAs. I have one with my company, but haven't contributed any percentage yet as I am not sure how much I should contribute. What exactly is a Roth IRA? Additionally, what is the ideal contribution to a 401k for someone making $48K a year? 

 

 

401(k), IRAs
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June 2016
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Both Roth IRAs and Roth 401ks allow you to make after-tax contributions into these accounts, which allow the funds to grow tax-free—and distributions are tax-free in retirement. Roth IRAs and Roth 401ks each have their own set of rules. You should know them well before making any decision about changing your contribution strategy from your regular 401k deferrals to Roth 401k deferrals. It is important to note that retirement plans normally allow you to split your contributions between 401k and Roth 401k funds: It’s not an all-or-nothing decision.

Your current 401k deferrals are decreasing the amount of your federal and state income taxes. Roth 401k contributions, on the other hand, do not reduce your taxable income. They are considered an “after-tax” contribution. If you were to change your contribution strategy from 10% regular 401k, to 5% regular and 5% Roth 401k, you could be paying by my calculation $600 more in taxes at the Federal level, not including any additional state taxes. Please see the example below:

Scenario 1  
Gross Income  $ 48,000.00
10% Contribution into Regular 401k  $   4,800.00
Taxable Income  $ 43,200.00
   
Estimate Federal Income Tax   $  6,571.25
   
Scenario 2  
Gross Income  $ 48,000.00
5% Contribution into Regular 401k  $   2,400.00
Taxable Income  $ 45,600.00
   
Estimate Federal Income Tax   $  7,171.25
   
5% Roth 401k Contribution  $  2,400.00
(Roth 401k Contribution does not reduce taxable income)

In both scenarios you are contributing 10% of your income. But in scenario 2, because you are not deferring 10% of your income into a regular 401k and reducing your taxable income, your tax bill increases from $6,571 to $7,171 ($600). My calculation does not take into consideration deductions you might have, but can give you a sense of how contributing to a Roth IRA affects your tax bill. You could consider contributing according to scenario 1 and then contribute the tax bill savings into a Roth IRA in addition to your 10% 401k contribution, thus increasing your total contribution.

 

Ideal Contribution

Most financial planning studies suggest that the ideal contribution percentage to save for retirement is between 15-20% of gross income. These contributions could be made into a 401k plan, 401k match received from an employer, IRA, Roth IRA, and/or taxable accounts. This contribution goal can be applied to anybody saving for retirement. As your income grows, it is important to continue to save 15%-20% of your income so that you can invest the funds and grow your investments until you need to start taking distributions in retirement.

June 2016
June 2016
June 2016
June 2016