I am 33 years old, single, no spouse or kids. I earn around $50,000 a year, live in Texas, a relatively affordable state (no state income tax,) rent a home, no plans to buy a house. I am debt-free.
Right now, I am using the Fidelity 2050 plan (designed for retirement by year 2050) and I am putting 10 percent of my salary into my 401k (by putting in 5 percent, I get a 4 percent match from my employer, but 4 percent is the max ceiling they’ll give under any circumstance) and also 10 percent into a Roth.
I have no idea how this 401k or Roth should be strategized. I simply socked away 10 and 10 percent into each, respectively, because it seemed like a simple and easy percentage to remember.
How should I tweak my approach instead to be optimal?
I had choices like this in my Vanguard 401k, “retire @ decade” funds, and my CFP didn’t think much of them. His choice was to target the 401k at a mix of high growth stuff (basically low cost stock/index funds) and diversify in the after tax funds e.g. your Roth into a less (but still aggressive) risk pool, but I’m in my late 50’s so your profile is a little different re risk.
But, yeah, what MustangSal said: contribute your absolute max to the 401k right now; using before tax money is basically free money later because the taxes you didn’t pay will provide returns you wouldn’t see otherwise because you could buy more funds with the money and let that grow.
Thinking about this more: there’s nothing wrong with what you’re doing: splitting the difference between Roth/Traditional 401k. If that makes you feel comfortable, do that. In 32 or whatever years, you’ll end up with a mix of before/after tax money. You can fine tune as you get older and there’s little pressure right now to figure everything out as long as you’re contributing.
As far as investment mixes, look for low cost (check administrative fees, they should approach 0% as close as you can get) stock index (Russell 2k, S&P, etc) funds at this point, and don’t sweat down years in the next 10 years: just keep contributing and don’t panic sell, it all evens out.
Sooner or later you’ll want to diversify and get into bonds yadyada, so start learning about that now and make some decisions in a few years.
So long as you can afford it, your 10/10 is perfectly fine. Keep in mind that there is a cap on how much you can contribute to each, each year. You’re probably okay on the 401k for a while, but as your salary increases, you’ll reach that limit on the Roth contributions.
As things change (like deciding to buy a house), I would focus more on maintaining the same level of contribution to the 401k, and decrease your contribution to the Roth as your monthly spending increases.
Kudos to you, though. You are starting early enough that this should set you up well for retirement.
How about contributing the five percent to the 401(k), so you get the maximum match, then contribute as much to the Roth plan as you can. If you still have money left over after contributing the maximum to the Roth plan, contribute more to the 401(k).
OP already said they make $50k and contribute $10 a year (plus matching), which is quite an impressive ethic. Max contribution before 50 is $19.5k. I don’t think many people can save 20% of their income per year. Kudos.
You’ll get more returns contributing to the 401k because you’re contributing more money because you’re buying investments with before-tax money. In theory (and extremely likely) you’d get larger gains because you bought more investments.
While not everyone can put the IRS limit into there 401k,that should be their goal. And don’t try to rationalize putting less in. Oh I need a new car…I’ll put more in later.
You’re very close to maxing out your yearly Roth contributions, so I’d probably just push it to the max of $6K per year. If you can afford that and 10% towards your 401K, you’re doing well for your salary and age. As you get raises and promotions, I’d increase your 401K contribution as much as you can without noticing, keeping in mind that there is a cap you’ll hit eventually. I will say that the plan you’re on, assuming it is the Fidelity Freedom 2050 Fund is a tad more expensive that I like for a 401K option. It looks like it has an expense ratio of 0.75%, while something like a Vanguard index fund is 0.07%. You might want to at least look over your options, with an eye on expense ratio.
With all of that said, I think you’re doing a remarkable job with the amount you have decided to put away at this point in your career. Keep it up!
But the returns on the Roth will be tax-free when the OP eventually withdraws the money while the 401(k) returns will be taxed. And with at least thirty years of growth, that may be more important than that the 401(k) contributions are pre-tax.
Which end the money is taxed at doesn’t matter: what matters is the tax rate when you withdraw versus add, and that the growth is tax-deferred.
Imagine you had $1000 that you could invest in a Roth or a 401K and imagine the rate of return was 5% a year and you held it for 20 years before withdrawing, and imagine the tax rate was 10% across the board. If you invested in a Roth, 10% of that money would be taxed right away, so you’d only be putting in $900. After 20 years of growth you’d have $2387.96.
If you invested it in a 401K, you’d have all $1000 in. After 20 years of growth you’d have $2653.29, but after %10 taxes, you’d have $2387.96.
Yep - at 50,000 a year you’re good to go with Roth - the income limit for a single person is 139,000 (a lot more than I had thought, actually).
If you’re putting aside 10% in each of the two vehicles, you’re doing pretty well! You’re nowhere near the limit on the 401(k) - I think that’s about 16K a year. You’re getting close to the limit (6,000) on the Roth IRA, at 5,000 a year.
See if your workplace has a Roth option in its 401(k). With that, you’re subject to the much-higher 401(k) contribution limits, and you can do so regardless of how much you earn. If it is an option, consider putting some of your 10% in each version (Roth vs traditional). You’ll pay taxes on that portion now, but then it, and its income, will never be taxed again. You’re likely to be earning more, later in life, and that would really pay off. Plus, as with a Roth IRA, you can withdraw some of the principal early (not the earnings) without paying a penalty.
The optimal split between before-tax and after-tax investments is going to depend on your future tax rate. Which is difficult to predict, although you can always make some educated guesses/predictions based on politics and/or your personal situation.
Is your likely career trajectory one where you expect to be making a lot more money when you’re older? Are there significant family assets that generate income that might be yours at retirement time? That would suggest that your future tax rate will be higher than your current one, and you should weight more to after tax investments now.
You could also take a guess at long-term economic/policy/fiscal issues that might cause tax rates to change, but, well, good luck getting that stuff right.
Getting the free employer match money is more important than any of the above. A mix is a fine choice.
The contribution limit for a 401k is $19,500 for someone under 50, add $6500 for 40 and over. I assume the Roth is a Roth 401k, not an IRA, and subject to the same limits combined with the traditional 401k
I stand corrected on the 401(k) limit; was just tossing out a ballpark figure from memory.
The extra money (“catch-up”) is indeed 6,500 a year, though that starts at age 50, not 40. I wish we could do that but we don’t have the cash flow.
It wasn’t clear whether the “Roth” mentioned by the OP was a Roth IRA, or a Roth option on his 401(k). I assumed he meant a separate Roth IRA.
The limit on the Roth IRA (or a regular, non-Roth IRA) is 6,000 a year; 7,000 if he’s 50 or older. That’s regular IRA and Roth IRA combined. And, that’s separate from any 401(k) contributions.
As you noted, the 19,500 for the 401(k) is the total of regular and Roth-option 401(k), so the OP could theoretically put away 19,500 + 6,000, or 25,500, per year, in tax-advantaged accounts.
Which would be fantastic, and a great way to fast-track for an early retirement, though I suspect he likes luxuries like food, clothing and shelter right now.
This is just me, but I would stash away whatever the max amount you can in your 401K and take advantage of the employer match (free money!).
I would then put most of it in an index fund like Vanguard or Schwab’s S&P 500 funds (you can look up the symbols).
Be sure to reinvest your dividends - you use your dividends to purchase more shares, and that way, you can truly take advantage of compounding interest. I think it’s also better for tax purposes but don’t quote me on that.