Hi everyone, I recently landed a new job where the base 401(k) contribution for all FTEs is 12% of your salary. This is regardless of your contribution, with no additional match. I realize that this is unusual for most people and it is for me as well. In my last job, I got up to a 6% match so I maxed that out and didn’t think on it any further.
I currently contribute an additional 5% on top of the 12% that my employer provides, but got chatting with a coworker who mentioned that they were advised to take that money and, since it was not being matched, put it into the stock market instead. I’m open to learning, but have very little knowledge of stocks, cryptocurrency, or likely any other potential option you may suggest.
For a little extra information, I am in my mid-twenties, earn mid-five-figures/year, have little saved for retirement right now, and am open to any suggestions you may have.
So, what would you do in my situation? Thanks for any replies!
If you’re not particularly financially savvy, you should always put 10% into retirement in some sort of cheap index or target date fund.
Definitely do not fuck with individual stocks or god forbid, crypto, unless you are sure you know what you’re doing and prepared to lose 100% of your investment.
General retirement advice is to contribute 15% total to your retirement account. Since your employer adds 12%, you should contribute a minimum of 3%.
As for your coworkers advice, it may or may not be valid. Contributing to your 401k or a taxable account, both allow you to invest your money. The 401k comes along with tax advantages. Assuming you are making Traditional contributions, then you are saving taxes at the marginal tax bracket (potentially 22 or 24%). If you contribute enough to drop your MAGI to the 12% bracket, then the tax benefit is much less. You can still contribute to Roth, which means you can withdraw that money tax free in the future but you have to pay taxes on it now.
Another thing to consider is the fees in your 401k. Since you are limited to the options provided, sometimes fees are quite high. If you don’t have any options that cost less than 1%, you likely are better off investing your money elsewhere.
Finally, you get into the really personal part of personal finance. What are your goals? Do you have short/medium term goals that you would prefer to save this money for? For instance, if you want to save up for a down payment for a house in the future, putting that money in a 401k is a bad choice. Do you have a comfortable emergency fund to pay for unexpected expenses? Do you have high interest debt to pay off?
A good resource is this flowchart from r/personal finance: https://imgur.com/u0ocDRI
The main concerns here are:
- taxes - 401k contributions defer taxes (or prepay for a Roth account), and there’s only so much tax-advantaged space available
- investment options - 401k plans have limited fund selection, but many are good enough
If you’re planning to invest 5% regardless, choose the account that gives you the best tax advantages that matches your investment plan. For most, that’ll be the 401k in an S&P 500 or total US stock market fund. If the fees aren’t too bad, I’d absolutely go with the 401k.
If you’re in the 12% or below bracket, I recommend Roth if it’s available. If you’re above, deferring taxes is probably the better plan. If your funds are super expensive (say, >0.5% fees for an index fund), you might be better off in a taxable account.
The big advantage of putting your additional contributions into the 401(k) is that it reduces your taxable income. The big disadvantage is that the money is locked away for decades; that cash is no longer available to make big purchases like a car, honeymoon trip, etc. There are some exceptions, but be careful that you don’t get hit with penalties.
Personally, if I were in your situation, I would open a no-fee brokerage account and put you additional retirement money into an index fund that tracks the S&P 500 or NASDAQ. If you need the money before you turn 66 then it will be readily available.
Better yet, put it in a Roth. OP can still withdraw the principal penalty-free if they need it, meanwhile it grows tax free.
can still withdraw
That’s subject to plan rules.
grows tax free
If you pay the same effective tax rate now vs retirement, Roth and tax-deferred are equivalent. The benefit of Roth is that it gives you flexibility in retirement, so you can choose how much taxes you pay in retirement instead of whatever you happen to withdraw from your tax-deferred accounts.
So a Roth contribution isn’t an automatic slam-dunk, it really depends on OP’s tax bracket now vs retirement. If OP is in the 12% or lower tax bracket, I highly recommend a Roth contribution, but if they’re above it, I recommend taking the deduction. I’m a little below the top of the 12% bracket, so I actually convert my old pre-tax accounts to Roth up to the top of the 12% bracket since that’s a pretty good tax rate to lock in.
if it’s too good to be true, it’s probably not
12% even if you don’t put any in should set off alarm bells.
Like, who is managing that 401k? Is it related to someone running your company?
How’s the salary compared to similar jobs? Are you making 15% less and that’s where it’s coming from?
What is mid 5 digits? 50k? That means you’d be making 56k if you got it all in pay.
It’s not a bad wage, but something crazy like 12% 401k no matter what is usually for stuff at least twice your salary for tax evasion reasons.
I get not wanting to put details online, but you should find a coworker who’s been there a long time and ask about what’s going on. If no one’s been there more than a few years, that’s another huge red flag
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Most likely this is a category of 401k (or IRA) called a SEP IRA. It works to the company’s tax advantage and they have the ability to force it on all employees. All employees is a requirement of this. I don’t have a ton of knowledge about this, but about a decade ago I dug in to it because my wife’s company did this to us at a time we really needed more flexibility on what she was contributing. I don’t remember the nuances, but sadly I found it out that (at least at the time) while it seems sketchy as hell, it was legal if the company met all the requirements/followed all the rules to do this.
Employers are limited in paying into 401ks for highly compensated employees, and are required to have a certain percentage of their normal employees putting money in if they want to go hog for their execs. That’s why many give matches, to incentivize folks to contribute so that they can then funnel more to the C-suite.
Your coworker is right that the lack of match makes the 401k less appealing. That said, it’s still the stock market, but you may have severely limited options.
You’ll want to do what you’re required to do, but then you should look into a ROTH IRA, which will give you a lot more control over that extra 5%.
The best I ever had was a 6% full match, and the company contributed another 3% that I didn’t have to match. The result was company contributing 9% and me contributing 3%. So I agree with other comments saying you should probably be contributing about 15% total. That extra 3% doesn’t have to be in the same account though, you could open your own if you get better investment options with lower fees.
12% contribution that you don’t have to match is amazing and just make sure you’re fully vested before you take a new job. Sometimes there is a rule that those contributions are not truly yours until you’ve been at the company for a number of year.
As others have mentioned, you can invest in the stock market within your 401k, though your options can sometimes be limited or saddled with high fees depending on what broker the 401k is through.
If yours is through a shitty broker then you might be better served by opening an individual retirement account (IRA), likely a Roth IRA given the limited info you’ve shared. You can open one with a broker of your choice, so go with one of the better ones like vanguard or fidelity. Using tax advantaged retirement accounts will always beat saving your retirement money in a non-tax advantaged one, all else being equal.
Edit to echo the flowchart from one of the other comments: https://imgur.com/u0ocDRI
This is the core of sound personal finance strategy in purified form. Great resource!
If you have any debt (credit cards, auto, student loans), I would pay that off before adding more than the 12% to retirement.
If you are debt free and have some short-term savings, I would contribute to a Roth IRA before adding to the 401k. At a mid 5 figure income level, the tax savings from the 401k aren’t that impressive. Meanwhile, the IRA gives you some flexibility to draw funds for a first time home purchase, major medical expense, or potentially the option to withdraw prior contributions without penalty. You then have the flexibility to invest according to your knowledge and risk tolerance.
I would probably only choose the 401k if the tax reduction was meaningful and I earned too much for a traditional IRA (those 2 things typically coincide). Another possibility is if your company has a good ESPP program, ideally one that allows you to sell shares immediately after they are purchased (no minimum holding period). If there is a holding period (my employer requires 1 year), you have to think very hard about how much risk you are taking on during that time.
If there’s an option for the company contributions to be Roth I’d make sure to do that. Roth is a “suffer now, collect later” type of thing. You pay taxes now, and NOT during retirement (good because you’re young, likely in a lower tax bracket than you’ll be in during retirement, etc.). Even the earnings are tax free in retirement.
Anything extra you put in should also be Roth. There are IRS maximums for personal contributions, and a higher maximum for combined personal/company contributions. At your salary you likely will not encounter these maximums unless you are saving $1,875/month (which would make you hit the maximum in December) in addition to company contributions.
To 401k or not to 401k – I say 401k. With Roth you pay now, not later. With traditional you don’t pay now, but pay later. Outside of 401k you pay taxes now AND later (on the earnings).
I would put it all in VTI or VTSAX and read all I can about Financial Independence (FI). FI is great as a lot of the writing is intended to be accessible. Until you are more knowledgeable, then a broad index fund like VTI is great.
If you won’t miss the 5%, then contribute it. There are two contribution limits for 401Ks, one for money you put in and another that includes that amount your employer puts in.
I would aim to save as much as you can when it does not hurt. Some in 401K, some in a bank account, and other in a brokerage. 6 month emergency fund and all that. 50% or more saved each month will be great for your future. I have run at 50% 401K contribution.
The best I ever had was a 6% full match, and the company contributed another 3% that I didn’t have to match. The result was company contributing 9% and me contributing 3%. So I agree with other comments saying you should probably be contributing about 15% total. That extra 3% doesn’t have to be in the same account though, you could open your own if you get better investment options with lower fees.
12% contribution that you don’t have to match is amazing and just make sure you’re fully vested before you take a new job. Sometimes there is a rule that those contributions are not truly yours until you’ve been at the company for a number of year.
Does your 401k allow you to invest in individual stocks? Does it let you invest in an index fund that matches your investment interests?(like one for just tech companies, or just solar companies, etc).
If you’re able to invest from within the 401k, do it. You’ll get tax benefits.
In terms of general advice though, I’d lean on the 401k here and invest in large index funds (total market, or at least tracking the SP500, or target date funds). This assumes you already have a fully funded emergency fund though.
Max out your Roth IRA ($7000 this year) before contributing extra to 401k. Do a mutual fund, not crypto or single companies. A target retirement date index fund is a good start.
