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I have a new job that pays ~100k. I'm in my early 20s. I'd like to figure out the most financially intelligent course of action when dealing with 401(k).

This is the policy:

X company will match 50% of each pre-tax and Roth dollar

you contribute to the Plan, up to 6% of your payroll

period compensation. Catch-up and after-tax

contributions are not subject to the match

The pamphlet then goes on about choosing funds may be right for me. It provides a flow chart asking whether Do you have the time or expertise to make investment decisions for your retirement account? I'm pretty sure that the answer would be no for me. It then gives two options Target Date Retirement Funds and Retirement Plan Advice powered by GuidedChoice.

My Question

How much should I put towards retirement? Which of the plans should I choose? Or how do I decide?

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You should be saving as much money as you can afford in your 401k up to the maximum allowed. If you don't contribute at least 6%, then you are essentially throwing away the match money that your employer is offering. Start out with the target date fund. You can always change your investment option later once you learn more about investing, but get started saving right away and get that match!

  • Assuming that you can afford to do so, I highly agree with claiming as much match as you can, as soon as you can -- it's free money. And yes, target date fund is usually a good place to start; someone else has done all the strategizing for you. If you really can't afford to claim the whole match immediately, consider increasing it each year as you get raises – keshlam Jun 21 '16 at 2:27
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The policy you quoted suggests you deposit 6% minimum. That $6,000 will cost you $4,500 due to the tax effect, yet after the match, you'll have $9,000 in the account. Taxable on withdrawal, but a great boost to the account.

The question of where is less clear. There must be more than the 2 choices you mention. Most plans have 'too many' choices. This segues into my focus on expenses. A few years back, PBS Frontline aired a program titled The Retirement Gamble, in which fund expenses were discussed, with a focus on how an extra 1% in expenses will wipe out an extra 1/3 of your wealth in a 40 year period. Very simple to illustrate this - go to a calculator and enter .99 raised to the power of 40. .669 is the result. My 401(k) has an expense of .02% (that's 1/50 of 1%) .9998 raised to the same 40 gives .992, in other words, a cost of .8% over the full 40 years. My wife and I are just retired, and will have less in expenses for the rest of our lives than the average account cost for just 1 year.

In your situation, the knee-jerk reaction is to tell you to maximize the 401(k) deposit at the current (2016) $18,000. That might be appropriate, but I'd suggest you look at the expense of the S&P index (sometime called Large Cap Fund, but see the prospectus) and if it's costing much more than .75%/yr, I'd go with an IRA (Roth, if you can't deduct the traditional IRA). Much of the value of the 401(k) beyond the match is the tax differential, i.e. depositing while in the 25% bracket, but withdrawing the funds at retirement, hopefully at 15%. It doesn't take long for the extra expense and the "holy cow, my 401(k) just turned decades of dividends and long term cap gains into ordinary income" effect to take over. Understand this now, not 30 years hence.

Last - to answer your question, 'how much'? I often recommend what may seem a cliche "continue to live like a student." Half the country lives on $54K or less. There's certainly a wide gray area, but in general, a person starting out will choose one of 2 paths, living just at, or even above his means, or living way below, and saving, say, 30-40% off the top. Even 30% doesn't hit the extreme saver level. If you do this, you'll find that if/when you get married, buy a house, have kids, etc. you'll still be able to save a reasonable percent of your income toward retirement.

In response to your comment, what counts as retirement savings? There's a concept used as part of the budgeting process known as the envelope system. For those who have an income where there's little discretionary money left over each month, the method of putting money aside into small buckets is a great idea. In your case, say you take me up on the 30-40% challenge. 15% of it goes to a hard and fast retirement account. The rest, to savings, according to the general order of emergency fund, 6-12 months expenses, to cover a job loss, another fund for random expenses, such as new transmission (I've never needed one, but I hear they are expensive), and then the bucket towards house down payment. Keep in mind, I have no idea where you live or what a reasonable house would cost. Regardless, a 20-25% downpayment on even a $250K house is $60K. That will take some time to save up. If the housing in your area is more, bump it accordingly.

If the savings starts to grow beyond any short term needs, it gets invested towards the long term, and is treated as "retirement" money. There is no such thing as Saving too much. When I turned 50 and was let go from a 30 year job, I wasn't unhappy that I saved too much and could call it quits that day. Had I been saving just right, I'd have been 10 years shy of my target.

  • I still mostly live like a well-funded student, 30+ years into my career... which is a large part of why I could have paid cash for the house if I'd wanted to, and certainly part of why I theoretically could retire now. I'd be in even better shape if I had started taking advantage of the 401k and stock purchase plans during my first decade with the company. – keshlam Jun 21 '16 at 14:22
  • I agree with this, especially the bit about looking into your fund expenses and maxing out a Roth IRA. So, 6%, max out the Roth, then put the rest into your 401k or into an after-tax brokerage account depending on your goals and the fees of your 401k. – TechnicalEmployee Jun 21 '16 at 14:45
  • Thanks, but Im wondering where you draw the line for general savings and retirement savings. If I move money to retirement savings im essentially moving it out of my regular savings account. – Daniel Jacobson Jun 21 '16 at 18:15
  • Please read Everyone says save at least 10% of your income. What counts as “saving”?, it should be helpful, even though it's a bit different. I'll edit my answer to clarify this nuance. – JTP - Apologise to Monica Jun 21 '16 at 19:31
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With painful 20/20 hindsight, I earnestly say - max it out hard. The reason is the sheer opportunity of it. As a young person you have time on your side - you have so many years for the earnings to compound! It is many times more advantageous to max it out now, than fail to do so and be in your 40s trying to catch up.

Use the Roth 401K if your company supports that. After that, max out a Roth IRA if your income is low enough to use them. Otherwise, max out a traditional IRA (this will not be tax deductible because your income is too high), and the next day, convert it to Roth. That conversion will be tax-free since you already paid taxes on that money.

401K money is untouchable. No one can ever take it from you - not with a lawsuit, not with bankruptcy. As such, never give it up willingly by borrowing from it or cashing it out early, no matter how serious the problem seems in the short term.

How do you invest a 401K when the market is so scary? I found out when I became a Board member overseeing management of an endowment. Turns out there's a professional gold standard for ultra-long-term, high growth, volatility-be-damned investing. Who knew?

  • "Use the Roth 401K if your company supports that. After that, max out a traditional IRA. Why? To get the tax savings now while you're in a high bracket. At some point, you're going to have a gap year or a cr * p year, where you have little or no income. In that year, you convert to Roth and pay the taxes in a much lower bracket." The same reason you suggest to contribute to a Traditional IRA contradicts your suggestion to contribute to Roth 401k -- according to the reasoning he should contribute to Traditional 401k rather than Roth 401k. – user102008 Jun 21 '16 at 8:22
  • "When your salary is too high for a traditional IRA to be tax deductible..." For someone contributing to their 401k (which is what you're suggesting that he does), he will almost certainly not be able to deduct a Traditional IRA contribution, unless his income this year is super-low (below $61k); and if it is that low, then his low tax rate would mean Roth IRA is better anyway. So deducting a Traditional IRA contribution is never really an option. – user102008 Jun 21 '16 at 8:25
  • Because presumably, in a gap year, you will no longer be employed by the firm that provides the 401K. So the 401K administrator would be reluctant to help you convert it to Roth 401K. By THEIR logic, you're no longer an employee, have no business here, and should really convert this to one of their private IRAs, which solve your Roth conversion problem and they know how to do it. Of course, they don't give a foo about your liability shielding. Some states protect IRAs thus converted, others do not. – Harper - Reinstate Monica Jun 21 '16 at 8:36
  • Very good point - I forgot trad. IRAs cap out much lower than Roths if you have a 401K available to you. Edited. – Harper - Reinstate Monica Jun 21 '16 at 8:41
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    "401(k) money is untouchable" - really? You've never heard of QDRO? – JTP - Apologise to Monica Jun 21 '16 at 11:58
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Direct answers to your questions: contribute 6%, and put it in the Target Date Fund (probably Target Date Fund 2050).

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