I know the limit you can contribute is 15%. Thanks to the length of time I’ve been at my job, my work performance and a recent wonderful raise, I’m contributing 13%. I believe the company match ends at 6%.
Now, I’ve heard two schools of thought. The first is, contribute to your employer match and stop. Then, invest the rest yourself in a Roth IRA or somesuch. The second school of thought is to contribute as much as you feel comfortable with, since it’s pre-tax and lowers your tax liablity.
I know the 401k is pre-tax and the IRA is post-tax. I have a Roth IRA that I’m also contributing to.
Dopers, what do you do? Are you maxing out your 401k past your employer match, or do you go up to the match, then fund your other investments yourself? If there are any CFP-Dopers I’d appreciate your input.
Personally I max the 401k out, primarily because of the tax savings. The caveat there is whether your plan offers a range of investment options that will allow you to get good returns and diversification. Mine does offer a number of options including real estate. I still end up using after-tax money to invest in some other options not avilable through the 401k such as emerging markets or to achieve a portfolio tilt depending on my market view. In the end, its really hard for me to argue against using the pre-tax funds.
Anyway, the reasoning I have heard for maxing out your 401 K at the company match is just to get the free money from the company (the match is basically free money). The reason you don’t want to do more than that is the early out penalty.
Of coarse, these are going to depend on each persons actual situation. In my situation, going higher than the company match isn’t going to lower my taxes. I am also working on a down payment for a house. So I am maxing out the match and that is it.
You also have to factor in the persons saving ability. If the person has problems saving and investing then it is obviously better to have them automatically take out more so that the person can’t spend the money.
We max out our 401(k) contributions before all else. Our thinking is that the more money we get in now, the longer compound interest has to do its magic. Both Mrs. Giraffe and I were in graduate school until our late 20’s and didn’t save anything for retirement during that time, so we want to make up for that as much as possible, so as not to spend our retirement years eating out of garbage cans. Or at least not really dirty garbage cans.
Fidelity also does our 401(k), and the information they give us is 30% of our gross, and we can put in either pre-tax or after tax. I was at 15% a few years ago, when that was the limit, but lowered it to the company match to work on paying off the credit cards. Still working on that, but making progress.
Your decision also depends on your tax bracket now vs. your anticipated tax bracket post retirement. You don’t pay tax on 401k contributions, but you do pay tax on the distributions. With a Roth, you don’t pay on distributions since that money has already been taxed.
If you’re not making a large enough salary to push you into the tax bracket you think you’ll have during retirement, it makes sense to pay the tax now (when it’s lower) and put everything post match into a Roth (assuming you have a good 401k). On the flip side, if you’re in your peak earning years and have a higher tax bracket than you think you’ll have during retirement, you should max out your 401k.
The 15% may have been a legal max at one point, because I vaguely recall that also. However in the past few years, I know my employers have allowed me to exceed that percentage as long as I didn’t exceed the annual dollar ceiling. I could have theoretically contributed 100% of my take-home at one point (though I’d have hit that 14K limit rather fast of course!). Some employers may still enforce that though.
The standard advice is that first, you put aside enough to get the full match from the employer, because that’s free money from the employer. Don’t forget to spread that out though - if you do 12% one month and zero % the next, you get the same amount of your own money (12%) but you don’t get the employer match the month you don’t contribute and you only get matching on 6% (or whatever percentage) for th month you do contrbute.
After that you have to look more closly at your own tax situation and needs. Depending on your own income limits, you might be able to do a standard deductible IRA, a standard RA w/ post-tax money, a Roth, or you might even be priced out of the Roth range (if your income is too high, e.g. 110K as a single person). Or you might be better off putting more 401(k) money aside.
One advantage of 401(k)s that affects other areas of your tax returns: since it lowers your taxable income, obviously it lowers your income tax hit directly. BUT it can also help you with some things that phase out as income increases - e.g. child tax credit, phaseout of itemized deductions. I don’t know if that extends to helping stay within the limits for Roth contributions though, or deductible standard IRAs.
If you think you might need to get your hands on your money pre-retirement… 401(k) offers the option of taking a loan against your own funds but of course if you change jobs you have to pay back or pay a huge tax hit and penalty. If I understand correctly, a Roth allows you to withdraw your principal w/o a penalty but there may be some limits (e.g. it has to be left in for 5 years before withdrawal, or something like that).
Whether Fidelity is the trustee or recordkeeper has nothing to do with how much your employer allows you to defer. The maximum amount the company allows is written in the Adoption Agreement and may be lower than the IRS limit. You might have a 15% of comp max in your plan managed by Fidelity, and someone else might have a 100% of comp in the exact same type of plan also managed by Fidelity.
You’ll also have to pay back the loan if the plan terminates, and you might only get a few weeks notice that this is going to happen. Very hard to come up with the balance on a large loan with only 3 weeks’ notice. (Or take the 20% immediate tax withholding, plus probably more owed when you file, and 10% penalty.)
Is it not the case that there can be different maximum contribution percentage for certain “highly-compensated” employees, to make sure that they don’t run afoul of some regulation that tries to make sure that the upper management isn’t the only ones benefitting from the plan? Perhaps that is another reason why some plans max out at %15?
As for myself, I contribute up to when my employer’s matching maxes out. Perhaps if I had a plan that let me invest in Vanguard (or, temporarily, Fidelity, as I fear that their much vaunted low fees might not be around for long.)
I put the rest in a Roth: if and when I’ve maxed that out too I pay down my loans early (I usually save up enough to pay off my car loans early, but haven’t been able to touch the mortgage yet.)
I’ve had about a half dozen 401K’s over the years. There is no max contribution percentage set by the government. About half of employers have one, IMO.
The most useful thing about having no limit, I guess, would be a high income individual who just wants to hit the 14K limit ASAP. Put in 100% of a 100K+ salary and you can max out in a couple months.
A neat trick that I’m a fan of is rolling your old 401k’s over to Roth IRA’s. It’s great because it avoids the whole contribution limit problem. You will owe a tax on the transfer, though, but it’s well worth it if you are a younger worker. Paying $.30 tax on a dollar now is fine with me because it means I’ll get back several tax free dollars on retirement!
I have no plans to touch my money pre-retirement. I look at my 401k and IRA as money that is not mine. It’s working so when I retire it will be there.
It sounds like I will need a more comprehensive overview of my finances to decide which works best for me. I thank everyone for their help. I think I’ll leave things as they are now until I can locate a CFP.
Oh, don’t do that. The amount that you’ll spend on a CFP is probably more than any money you would lose by making the wrong choice between using a traditional IRA or a Roth IRA.
If you still have money left over after that, find a low cost brokerage.
Any “investment money” you pay right now, is money that is not being invested for your retirement – that includes money paid to brokers, advisors, money spent on investing books, investing websites, etc.
It’s this easy:
Max out whatever they match since that’s free money, 100% return on investment.
Decide whether you want to put whatever else you can in a traditional IRA or a Roth IRA.
As for choosing what you want to invest in, that’s a whole different story.
There are lots of calculators available for seeing which one makes more sense, but the thing is, you’re probably just guessing what tax bracket you’ll be in when you retire, and what the tax rate will be. You’re definitely guessing what your average return will be. Your CFP isn’t going to know any better than you.
Keep in mind that putting $4000 in a Traditional IRA pre-tax is like putting only $3000 in a Roth, assuming you’re taxed at 25%.
You need to determine whether the $3000, not taxed when you retire, is worth more than $4000 taxed at your future rate when you retire. I think that Roth works for most people, and if you can eat the taxes right now, why not. . .but it’s not as big a slam dunk as some people think.
Yes, there is - it’s called 415 Annual Additions, which means that no one can contribute more than 100% of salary or $41,000 (in 2005), whichever is lower.
There are also IRS regs on the percentage that Highly Compensated Employees can contributed as compared to Nonhighly Compensated Employees, but this can vary from year to year and is determined based on the results of annual compliance testing done after the plan year has ended. This is called a Actual Deferral Percentage Test and depending on how many employees total there are and how many participate, could result in the HCEs being able to defer only 1% (or less) of comp. They get the excess that they already deferred throughout the year back as a taxable refund.
Then there’s the Plan Deferral Limit, which the company chooses and the IRS enforces - it might be 15% of salary, as someone else mentioned.
This is a good point. It should also be noted that if you expect to be in the same tax bracket when you retire, there is no difference between the Roth and the 401(k) in terms of how much money you’ll end up with.
For example, if you invest $10,000 for 30 years and get an 8% annual return, and are in a 30% tax bracket both now and when you retire:
Roth: $10,0000.70(1.08)[sup]30[/sup] = $70,438 after taxes
401(k): $10,000*(1.08)[sup]30[/sup]*0.70 = $70,438 after taxes
I think the key differences are that a 401(k) will allow you to stretch your money farther by taking out less and paying less taxes, while a Roth will allow you to spend a large sum all at once without a tax hit (assuming there aren’t limits on how much you can withdraw from a Roth at retirement). And, of course, most of us expect to have a lower income when we retire than when we’re working.
Another point - the above scenario isn’t allowed, as I already said (415 Test), but even if it were: it’s more beneficial to extend one’s deferral as long as possible in order to receive the greatest amount of match. The earlier someone maxes out at $14,000 (this year), the less match he gets. This means that someone with a high salary should NOT defer the maximum percentage allowed but should defer a less percentage that will still allow him to get up to that $14,000 limit but will take all year to do it. (As long as match is given each month or pay period.)
As an example: for my employer’s employees making over $205,000 in 2005, with match being granted bi-weekly, the optimal deferral percentage was 6%. This would allow them to defer almost the entire year before hitting the $13,000 limit and receive match each pay period. Someone who deferred 15% of pay would hit the $13,000 limit much earlier in the year and thus stop receiving match for all the months remaining.
Still working on that, but making progress.