Help Allocate My 401(k)

Seriously. I have no idea how I ought to be doing this. I’m 31 and my employer doesn’t offer matching so I’m not maxing out my contributions right now (though I’m upping my contribution to 10% of income.) Over here, jasg notes that index funds have lower fees but there don’t see to be any of those offered by my employer and/or its 401(k) provider (ADP). These are my options:

My current balance is split three ways between Blackrock Global Allocation, Ivy Small Cap and Pioneer Emerging Markets.

If there’s no employer match, why don’t you just invest in an IRA instead? Those options all stink.

Other than a broader choice of investmernts, what’s the benefit? I’ll hit the IRA contribution limit in a year or two. I’m a long way from hitting the 401(k) contribution limit.

I can’t provide specific advice but some broad stuff would apply. When you say you’ll hit the contribution limit in a few years do you mean you’re 68 or so?

Also, define for yourself how much risk you’re willing to tolerate and look for funds that shoot for that goal.

I think he means that he will hit the IRA contribution limit, which in 2014 is $5,500.

Through an employer sponsored 401(k), the limit is significantly higher - $17,500.

If you are contributing $5,500 or less to your retirement, and your employer does not match, then the traditional IRA is superior. Otherwise you should go through your employer. Also consider a ROTH IRA if you meet the income thresholds.

Well it does depend on how much you make, but you can deduct traditional IRA contributions from your taxes, and Roth IRAs are ideal if you expect to be in a higher tax bracket at retirement.

That said, the broader choice of investments is a big deal. Your number one priority should be avoiding fees.

I was looking through your choices for something like the S&P500 index fund but couldn’t find anything equivalent to that. The Janus Enterprise Fund is a mid-cap fund, so you might contribute to it. But you’re right; it’s a poor selection of funds and I’ll bet the fees are high. You might campaign for your HR department to change the trustee.

To sum up, would it make sense for me to put $5,500 in a traditional IRA and then contribute any overage to the 401(k)?

No, what Bone said: I will be contributing $5,500.

… my 401(k) contributions are tax deductible, so I’m not really seeing how that’s a benefit.

The fees for each of these funds will be identified in the materials provided by them. They should generally be pretty close to each other. You can compare those fees to those that are offered by index funds outside your employer’s selection pool. Generally I’ve found the Vanguard index funds to have some of the lowest fees.

Now a days they have funds based on your age. You can stick with the fund and it will adjust the risk downward over time. Keeps it pretty simple if that is available to you.

At age 31, if you are not married and have no kids (i.e. less responsibilities) then I would go for a large portion (60% or so) in higher risk areas. Take advantage of your time horizon. I assume that you are comfortable in your contribution amounts and you won’t need to draw on them for a loan or anything like that.

ROTH IRAs switch the timing of the tax. For traditional IRAs and 401(k)s, they are not taxable when you earn the dollars, but are taxable when you withdraw the funds, including any gains.

ROTHs are the opposite. You pay your current tax rate now on everything that you put in, and then when you withdraw it’s not taxable, including any gains. THere is an intersection of curves when this is more worth it - some factors are time, and future tax brackets.

I’m not reading through all of that, but I will tell you that the allocation of your funds has much to do with your age and how long it will be before you retire. Do some research on income vs. growth.

I’m interested in learning more about these curves. Let’s say I have both a roth and a traditional. What proportion of my 5500 should go into each?

The tax deductibility of your traditional IRA will be affected if you also participate in your employer sponsored 401k. Depending on your income level, the IRA contriutions will not be tax deductible (no affect on the limit, yay). I believe if your AGI is over 60K you begin a phaseout, and after 70K (for filing individually, these all change if you file married) you lose the deduction entirely. These figures get adjusted each year, but they are in the ball park.

Should have mentioned: I’m married, and we file jointly.

The fees all seem to be in the 1-1.2% range. The Global Allocation thingy has a fee of 1.49 (and an abysmal return since I bought it) so I’ll be getting out of that one.

In general, the suggested way to contribute is:

  1. 401(k) until you hit the employer match.
  2. Traditional or Roth IRA until you hit the contribution limits
  3. 401(k) past the employer match until you hit the 401(k) contribution limit
  4. Taxable account

So since your employer match is $0, skip directly to step 2. In an IRA you have more freedom to avoid fees and select the funds in whatever allocation you so choose.

As has been mentioned, a traditional IRA lets you avoid taxes now in order to pay taxes in retirement on your withdrawals. With a Roth, you’ll pay the taxes now in exchange for tax free growth and tax-free withdrawals later. There are some subtle points aside from that. One subtle point is that since you’ve already been taxed on the contributions to the Roth, so you can withdraw them at any point without penalty, whereas you have not been taxed on a traditional IRA’s contributions, so you have to pay taxes and a penalty if you try to withdraw them later. There are a few other points, as well. In general, if you are young a Roth will probably be better for you in the long run, but you should really check the numbers to be sure.

If you file married, then the AGI limit on deducting your IRA contributions phaseout is 96K to 116K. That assumes you are both covered by an employer 401k. It’s different if one of you is covered and the other isn’t. Yay simplicity.

I don’t believe these limits on IRA deductibility are affected by your contribution to your 401k or not. If you have the 401k available, then the limits apply.

For reference, the fees on most index funds with Vanguard are on the order of 0.04-0.3% for most common funds.

Okay, I rebalanced my current balance to the funds with the lowest fees versus 3 year return.

The wife is also covered by an employer 401(k), with match. Bone: are you saying that if we have a combined income of $96k-plus, our contributions to an IRA would not be fully deductible? I guess I’ll talk to the bank about setting up an IRA.

(my bold)

This isn’t quite right. Early withdrawal penalties (10% of the withdrawal taken prior to age 59.5) apply to ROTH IRAs unless you meet one of the exceptions, and/or based on the timing and characteristics of your withdrawal (earning vs. contributions). You don’t get taxed since you’ve paid the tax already, but you are still subject to penalties in some circumstances.