Maxing out my 401K

[eggzz]

Can someone please clear up a misconception I have in regard to this statement/piece of advice one routinely hears in regard to 401ks:

"You should always max out your contribution to your company 401k"

My company offers what I believe is industry standard, a 3% match. For the first 5 years with my company, I contributed 6% of my income, and received the maximum company contribution I could get.

So am I or am I not maxing my 401k contribution? And when I ask that I ask in terms of what you normally hear from advice givers.

Or, since my company allows me to contribute up to 18% of my salary to my 401k, am I woefully undercontributing?

FWIW, I also contribute $2,000/yr to a Roth IRA and I also contribute $2,000 to an ExxonMobil DRIP. I realize people would tell me to maximize my Roth IRA contribution and I understand that, but that is not what I'm asking here.

I can probably afford to squeeze some more money into one of those three investments that I am involved in. So second question is, which one would you throw $ into if you were me?

If you need more background, I am 35 years old, single/head of household, one 5 year old child, live with significant other, make high $50's in salary, no debt other than house, and a small HELOC.

Thx.

[Sniper]

Maxing out your 401K means exactly what it says... if your company allows you to contribute 18% of your salary, then maxing out would be putting 18% of your pretax gross into your 401K.

One of the most important pieces of the puzzle in deciding how you should allocate your retirement savings, is how much do you have saved today vs how much you will want to have saved in X years to actually retire on. Or put another way, what do you want your life to look like when you no longer have a regular paycheck coming in!

A secondary question is, how to bring in the money today, so that you can set aside the proper amount to live comfortably (as you define it) in retirement, and at the same time live a comfortable life today.

[Mr. Now]

The mega-positive thing to do is make sure you contribute enough per year to get those matching funds from the employer. This is an automatic 100% return (subject to standard vesting rules). So you always 'max out' your contribution such that you capture ALL of what the employer is offering in terms of match.

If you want to go over and above, contribute more. But, after the employer match gives you an instant 100% return (subject to vesting rules,) each additional dollar saved in that 401K offers you much less reward. If the employer matches dollar-for-dollar up to 3% of annual salary, by all means contribute that 3%.

All contributions up to IRS maximums for 401K accounts reduce your taxable income and can generate tax-deferred gains to the extent you actually have gains. This can greatly boost total return because there is no immediate "rake" on your profits, allowing you to compound with those profits.

The tax on these accounts comes out when you withdraw the cash. The cash comes out taxed at your then-current tax rate.

Regarding your question about where to focus new contributions: be careful about the 401K at work-- look at the rules. They may limit the scope of investment options you have. See what kind of limitations are imposed on your investing universe in the company 401K. If you are OK with the limits then focus money there. Often the employer match has a limited universe of investment options also. They can impoise these limitations because after all it is "their money" until you vest 100%.

Anything YOU contribute comes with you 100% when you leave, but the employer contribution-- those 3% matching funds-- they have a vesting schedule (meaning you gain more and more of it over your employment time) so make a note to find out exactly what the schedule is, because that may impact the timing of any decision to bug out of the current job for a better one. For example is you are 60% vested on a total of $50,000 employer contribution, you wil be leaving 40% of that if you bug out now. That 40% of 50K is not chump change. Usually the vesting is 20% per year or a "cliff" vest of 100% typically 5 years after the contribution. These gotchas are designed to keep you retained by your employer.

Gotta watch those employers.


I hope this helps.

[eastbay]

Agree with the responses so far.

I think I've gone kind of hog wild with my pre-tax investments. I sock away a full 25% of my gross in these plans. I figure it's safer in there than in my grubby little hands.

eastbay

[Sniper]

In this case, eggzz has been with the company for 5 years, and is therefore likely fully 100% vested in any company matched 401K funds.

Additionally, I disagree with the statement.. "If you want to go over and above, contribute more."

Its not about "want"ing to contribute more... You must determine how much you NEED to contribute, and "pay yourself first"!

[eggzz]

Yes, thanks guys, I have been with this employer for 9 years, and have been fully vested since year 5. I should also add that this is not a publicly traded company, therefore I don't own any company stock. They have a good array of funds, currently I'm in 4 different fund families, 30% International, 30% small cap, 20% mid cap and 20% large cap.

I love my XOM account too, every time I send them a check for $200, in my mind, I picture to myself that I just bought four barrels of oil.

I think I'm going to ramp up my 401k percentage to around 9% for now, and anything extra will probably go to the Roth IRA.

[Mr. Now]

HI Sniper,

Thanks for responding here. My point there was after capturing all of the employer-match, he now has various pre-tax saving options, of which contributing more to THAT plan was one of many options to him available. (with caveats)

Your point is important-- "know what you need to do to achieve specific projections and specific goals."

I think the main thing many younger readers of this forum need to understand is the urgency of getting started saving and investing ASAP-- start very young. As young as possible !! Why?

One more doubling period at the end (around age 55-65) means you end up with TWICE as much money as the guy that starts saving and investing (at the same 40-year average rate of return) later, for example one doubling period later.

That difference is huge at the end and can amount to a difference of several millions.

For example 2 guys both 25 both save exactly the same amount per year and get the same average lifetime return of 11%

OK 11% money doubles roughly every 6.54 years ...

Person1 starts at 25 and Person2 starts at age 31.50.

At age 65 Person1 got roughly 6 doubles on his savings while Person 2 gets roughly 5.

Person1 hits age 65 with roughly twice what Person2 gets there with, assuming they both save the same amount every year and average the same return over their pre-retirement lifetimes.

To compensate for starting late, Person2 has to save loads more per year (starting at 31.5 years old) than Person1 (who started at 25)

[Misfire]

Once you've "maxed out" your employer match, there's not much reason to continue adding to the 401k until you've exhausted other tax-deferred or tax-free options. A 401k and a traditional IRA work about the same for tax purposes, but the IRA gives you virtually unlimited investments to choose from.

Also, you may want to consider a Roth IRA where the tax is paid now and the growth is tax free. This is advantageous for anyone who believes their tax rate will be higher when they retire than it is now. If this is the case for you, you'll also want to see if your employer offers the new Roth 401k.

If I were you, I would plan on investing at least 15% of my gross pay. Start with the 401k up to the max (Roth 401k if possible), max out a Roth IRA for the year (max one out for your spouse too if you can), and then go back with whatever is left over and add that to the 401k as well.

[jively]

[ QUOTE ]
Once you've "maxed out" your employer match, there's not much reason to continue adding to the 401k until you've exhausted other tax-deferred or tax-free options. A 401k and a traditional IRA work about the same for tax purposes, but the IRA gives you virtually unlimited investments to choose from.

Also, you may want to consider a Roth IRA where the tax is paid now and the growth is tax free. This is advantageous for anyone who believes their tax rate will be higher when they retire than it is now. If this is the case for you, you'll also want to see if your employer offers the new Roth 401k.

If I were you, I would plan on investing at least 15% of my gross pay. Start with the 401k up to the max (Roth 401k if possible), max out a Roth IRA for the year (max one out for your spouse too if you can), and then go back with whatever is left over and add that to the 401k as well.

[/ QUOTE ]
All of the suggestions in this thread were good, and this post is spot on. If you think about what kind of tax rates we've had for the last 40 years, we are probably near a low in the cycle. Tax rates will probably be higher in 20-30 years. That makes Roth accounts a better deal.

-Tom

[MatthewRyan]

Max your Roth, you're being foolish not to.