I am in my early 30's, and currently I am putting away about $12,000 a year into my 401(k) with a balance around $48,000.

Also, two years ago I decided to start a Roth IRA because I figured it would be nice to have some tax free distributions when I retire. I am putting in $2,000 a year, but plan to bump that to about $3,500 once loans are paid off.

Should I focus on maxing out my 401(k) or continue with my current strategy? I am taking advantage of my company's full 401k match.

  • Why can't you diversify within the 401(k)? Mutual funds are usually used in 401(k) and have some inherent diversification. Can you manage your 401(k) such that you're in more than one investment option within the 401(k)? – Freiheit Oct 18 '17 at 15:04
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    I am talking about having tax free income (roth ira) and taxable income (401(k)) when I retire. – user2600629 Oct 18 '17 at 15:11
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    Does your current 401(k) offer a Roth option? – mhoran_psprep Oct 18 '17 at 15:49
  • Can't you do both? As long as you are under a certain income limit you should still be able to contribute to a Roth IRA even if you max out your 401(k). – Rocky Oct 18 '17 at 16:47
  • Do you think your tax rate will be higher now than when you retire (which means that you should be weighted more towards 401(k) and Traditional IRA) or that they'll be higher when you retire than now (meaning weight as heavily as possible towards Roth). – RonJohn Oct 18 '17 at 16:49

Opinions vary on this, but most recommendations I've read, and what I follow, is the following investment order:

  1. Establish an emergency fund to cover 6 months of expenses.
  2. If employer matches 401(k) contributions, max out their matching.
  3. Max HSA.
  4. Max Traditional/Roth/Backdoor Roth IRA depending on income level.
  5. Max 401k.
  6. Taxable investment account.

If you have debts, they often get prioritized after taking advantage of employer 401k match if they have high interest rates (guaranteed return, in essence), and many people don't worry about paying off longer term low-interest debts early, but some place them ahead of opening a taxable investment account.

The HSA piece is only relevant if you are on a high deductible insurance plan, the HSA popularity is due to the fact that contributions and distributions go un-taxed so long as the money is spent on qualified health expenses, and there is currently no time limit to claim expenses. This means you can pay expenses out of pocket and get distributions years later, thus benefiting from years of compounding tax-free growth. Some HSA's have poor investment options, so might have to go outside of employers, and the rules about reimbursement periods may change.

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    I'd make a strong case for swapping 1 and 2. The $10,000 it might take to load up the EF would be $26K (assuming 25% bracket) in the 401(k) with a dollar for dollar match. And since the typical match stops at 5%-6% of income, the rest can go to the EF, – JTP - Apologise to Monica Oct 18 '17 at 15:26
  • @JoeTaxpayer Yeah ideally you don't give up the match to fund an EF, but it can take weeks to get money out of a 401k, so I wouldn't put EF below 401k, in reality usually both happen in tandem, since 401k elections are made at employment onset and during annual enrollments, so I guess it doesn't matter much which order you put them in on a list. – Hart CO Oct 18 '17 at 16:03

The nice thing about the Roth IRA is that in an emergency you can pull your contributions out without penalty. This means even if you haven't built up a dedicated emergency fund you could use a Roth IRA as an interim emergency fund. That being said, I'd consider the Roth funds a last resort (truly an emergency) since you may not be able to put them back in that year. And of course if you don't have an emergency you have a Roth which you otherwise wouldn't have if you funded your EF with cash.

So, I'd max out the Roth IRA first to build up your lifetime emergency fund, then I'd go back and add more to the 401(k). If your company offers a Roth 401(k) I'd consider that too for a portion of your 401(k) contributions.

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