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I am in my early 20s and currently contribute ~18% of my income to my retirement accounts, 7% to company sponsored Roth 401(k) (Popular Investment Company) and 11% into my Roth IRA (A "Big 3" Company). My company also contributes an additional 4% to the Roth 401(k) automatically, no matter how much I contribute. Since they are both Roth accounts, I get the advantage of tax free returns, so that isn't a factor in this.

Here's the average rate of return for the investments (Split among Small & Large Cap Growth Mutual Funds). I've currently selected for each account:

  • Roth IRA Investments 5 year Annual Return: 19.05%
  • Roth 401k 5 Investments year Annual Return: 16.20%

I am aware that these rates of return can vary over time, so I don't want to contribute only on rates of return. They are the most aggressive funds with low expense ratios (<.08%) that I can get within those accounts.

Is there any general investing advice on how I should split these contributions between the two accounts? Are there any general strategies, such as splitting contributions 50/50, 70/30, or 90/10?

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  • Can you afford maxing out both? – void_ptr Apr 9 at 4:42
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    My company also contributes an additional 4% to the Roth 401k automatically - employer contributions are always pre-tax, and therefore would not be contributions to a Roth 401k. Are you sure your 401k has a Roth option, and is not a traditional 401k? – yoozer8 Apr 9 at 13:57
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    You don't actually have a Roth 401(k); you have a 401(k) plan with a Roth component, and are making contributions only to the Roth component. Your employer's contributions to your "Roth 401(k)" are actually tax-deferred contributions to the "employer match" component of your 401(k) plan with vesting schedules etc and will be taxed when you start taking withdrawals from your 401(k) plan. – Dilip Sarwate Apr 9 at 13:59
  • I had thought there was a question somewhere on the site already with answers that address this, but I'm not able to find it. money.stackexchange.com/questions/47856/… touches on a bit, but is more general, and doesn't specifically discuss 401k vs IRA. – yoozer8 Apr 9 at 14:18
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    @theastronomist No, the employer contribution is always pre-tax (non-Roth), even if it is a match for your Roth contributions. – yoozer8 Apr 9 at 15:10
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Generally, (and not considering Roth vs traditional status) the way you would want to prioritize/order these contributions would be the following:

  • 401(k) up to whatever is required to capture maximum employer match (in your case this is 0)
  • IRA up to maximum. Currently this maximum is the lesser of your earned income or $6,000 (or $7,000 if you are over 50). This limit changes from time to time
  • 401(k) up to maximum. Currently this maximum is $19,500 ($26,000 if you are over 50). This limit changes from time to time.
  • Taxable investment account

Note that the IRA and 401(k) are not investments themselves; they are accounts in which you hold investments. This is one of the key reasons for the order listed here. Often, the investment selection in a 401(k) plan is limited, and may be subject to higher fees than you can get on your own. Even when that is the case, the employer match is free money, so it would have to be a particularly horrible 401(k) plan for the match to not be worth it. If the available investment options in your 401(k) are good, or at least are consistent with how you would (or do) invest your money in other accounts, then the performance should be the same between them (unless you have different allocations). In this case, performance and cost would not be driving factors in the decision of investment order.

The other factor that drives this order is access to the money. Contributions to a Roth IRA can be withdrawn at any time, without penalty (although you cannot then return that money to the account). For this reason, some people use Roth IRAs as more of a tax-free emergency fund than a retirement investment vehicle. Conversely, you generally can't access 401(k) money without leaving your job (there are some exceptions, but it is very plan-dependent). So if you expect you might need access to this money in an emergency and want simpler access to it, it would be better to have it in a Roth IRA.

The taxable investment account is listed last simply because it does not provide a tax advantage. It does however provide the most liquidity. You can access the money at any time with no penalty (although you will have to pay taxes on any capital gains when you sell investments), but will be taxed on interest, dividends, and capital gains in this account. If your 401(k) has very high fees, it may make sense to put more money here rather than in your 401(k) plan (beyond capturing the employer match).

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    +1 You might want to add that in some cases, "high-income" people are not eligible to make contributions to a Roth IRA at all, or to make tax-deductible contributions to a Traditional IRA accounts, where what is considered "high-income" can depend on marital status and spouse's coverage by pension plan or 401(k) plan as well as AGI. – Dilip Sarwate Apr 9 at 16:26
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    You've also missed the backdoor (for the above high-income case) and mega backdoor Roths. The latter is huge if your employer allows it. – obscurans Apr 10 at 7:53
  • With an employer match and mega backdoor the limit is 58k, plus 6k IRA and another 3.5 to 7k HSA if you have it. 64k total tax deferred per year between IRA and 401k. – Chris Apr 16 at 0:45
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When faced with the dilemma regarding how to allocate retirement funds the general advice is to allocate enough money in the 401(k) to maximize the company match, then put money in the IRA until you reach the maximum IRA contribution, and then put more in the 401(k) if you need to save more.

The complexity for some is that their income, or their family income, will limit how much they can put into a Roth IRA, or how much of a deductible contribution they can make to a traditional IRA.

The reason for putting money into a IRA is to give more investing options when compared to the ones available to the 401(k) program. The annual costs for the funds is also expected to be cheaper in the IRA even when similar funds are compared.

Based on this statement:

My company also contributes an additional 4% to the Roth 401k automatically, no matter how much I contribute.

That would mean that you would get the full maximum at a zero% contribution rate in the 401(k).

That would mean if you need to only save $6,000 of less for your retirement, the funds should go into the Roth IRA. If you are 50 or older, the limit is $7,000.

I am wondering if there is any general investing advice on how I should split these contributions between the two accounts. Are there any general strategies such as splitting contributions 50/50, 70/30. or 90/10?

If you need to save more for retirement in 2021 than the $6K or $7K, then funds should be put into the Roth 401(k). The limit in the 401(k) in 2021 is $19,500 or $26,000 of 50 or older.

How that splits your retirement savings depends how much you want to set aside, and how that works with the limits.

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The type of account has absolutely no bearing on the returns. What you're invested in is what matters. Since the tax treatment is the same, there is no structural difference, other than contribution limits.

The main practical difference may be the choice of investments that you have. It sounds like you've been able to choose slightly better funds in the IRA, which might incline you to allocate more there, but they may also fall farther in down times (which hopefully will be less frequent that "good times".

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From an asset protection point of view...

i.e. protecting your assets from bankruptcy and lawsuit...

The 401(K) provides stronger protection. It has nearly airtight protection granted at the Federal level. "Can't touch this!"

IRAs are not protected at the Federal level. There are 50 different rules by 50 different states - some provide protection comparable to Federal 401(K) protection; others provide no protection at all. You can inadvertently change your exposure simply by moving from state to state.

From an investing point of view

I don't need to tell you "past returns" is useless information.

After that, closely watch expense ratios.

As you know, 401(K)s force you to buy mutual funds. John Bogle's book Common Sense on Mutual Funds thoroughly busts the myth that the best returns come from mad-genius stock pickers justifying their high expenses by picking fantastically good stocks. For instance 1.5% (of fund value per year) is a very common expense ratio. Fund expenses are a guaranteed total loss. I have index funds (which simply pick every stock) with 0.07% expense ratio. That 1.43% is a guaranteed, locked-in "net win" (or avoidance of loss). A genius stock picker with a 1.5% expense ratio would have to out-pick the index by 1.43% just to break even, and science shows stock pickers can't.

You don't get to choose your 401K provider. Sometimes, the 401K "takes advantage of you" by only allowing you into high expense-ratio funds (of their own brand, naturally). That is a case for investing more in the IRA. Regardless, balance those choices against what is available in your IRA (and any good IRA lets you hold pretty much any publicly traded stock or fund, and even derivatives).

So despite the heightened asset-protection risk, the IRA is useful for selecting specific funds, or balancing your portfolio to cover assets the 401(K) funds do not allow, or cover specifically enough. For instance a 401K might have a general "Foreign stock" fund; but you might want British vs continental funds, South American funds, Japan but not China, etc.

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