Company with high match for 401K vs IRA, which to choose?

Question

I am fortunate to be at a company with a pretty high 401K match, 50% with no cap.

Normally when I've saved in the past, I've done the 401K up to the amount matched, and then chose other savings options. In this case...I'm wondering if it makes sense to just completely max out my 401k before moving on to the Roth and then other types of savings.

Here's the wrinkle, at this point in my life if I were to fully max my 401k contribution, I wouldn't have much remaining for other retirement* savings.

So with that in mind, what's smarter in their 30's with two young kids who already has six months of emergency savings and began funding 529's for the kids.

1. Fully Max 401K and nothing else
2. Partially fund 401K and max out IRAs for self and spouse

For clarity, I am trying to pick the best place to put retirment money,should I fund the roth 100% then use the 401k or viceversa?

Answer 1

Max out the 401k. The uncapped match is a free 50% rate of return and no other investment can match this.

Answer 2

It's very tempting to max out the 401(k), for the reason Hilmar mentioned. Remember, though, that there's more in life to save for than emergencies. For example:

1. House down payment
2. Vehicle maintenance and eventual replacement (I don't count easily foreseeable irregular expenses as emergencies)
3. Vacation
4. Continued 529 contributions.

Answer 3

There is at least a tiny bit of consideration for diversity of retirement savings: tax deferred 401k with already-taxed Roth. But as has been said here, an instant 50% return on funds is virtually unbeatable, even if income taxes will need to be paid on it and its earnings in the future.

With that in mind, OP should check out his plan to see if they have Roth 401k possibilities. That is, he can pay the taxes on contributions to the 401k today and then withdraw them and their earnings tax-free at retirement age. The company contribution will remain tax-deferred, but again, this lends itself some diversity in savings which I do think has value given the uncertainty of future tax laws and rates.

Many 401k plans allow a mix of regular and Roth contributions, too, so OP may be able to tune this knob a little.

And if OP can't find direct documentation, it may be worth a quick visit with HR. A lot of times plan choices like that comes about because someone asks for it. It is possible that no one else has asked for it to date, but all HR has to do it ask their provider to turn it on for the plan. (As an aside, this is also a good avenue to ask your employer for funds in your plan with better expense ratios, better diversity, etc. These things often don't get changed until someone asks.)

Answer 4

The answer to this question is not set until the time you leave your employer. You could max out the 401K in July, and cut it back to 3% in August. That is the key to understanding the right course of action.

Given your fully funded emergency fund and the match, I would max out the 401K whenever you can. You may want to cut back on that savings for special needs like Christmas or when you might need a new car. However baring any other hinderances dump as much money as you can into your 401K. Nothing like getting a 50% return on your money from day one.

Keep in mind your employer's policy may change, the laws surrounding 401K may change, or you may change jobs. It is "time to make hay while the sun is shinning".

As far as college for the kids what do you envision? If you are planning on community college then transfer to university, it is fairly easy to just cash flow. You may not even need 529 savings. If needed you could cut back on your 401K then, after your earlier contributions and matches have had time to grow.

Answer 5

Take the FREE MONEY

I have to agree that the 50% match is free money. 50%, even though it only applies one time, constitutes years of growth even in the best conditions.

My own personal style is to max out the 401(K) up front - i.e. I fund the full $19,500 in the first few months of the year. It makes for an irregular paycheck, but it locks in the contribution even if I lose the job or change jobs to a company without a 401(K).

There are 2 tax categories here: Traditional IRA and 401(K).... and Roth IRA and 401(K).

There is a gotcha with a traditional IRA or 401(K)

Since you're not paying taxes today, you must pay taxes on withdrawal or conversion - and that can be an extreme burden late in life.

Now, the mathematicians in the crowd say "well, your tax rate will be lower in retirement" - snort those mathematicians haven't spent a lot of time in skilled nursing facilities. Here's what REALLY happens.

With a traditional IRA/401K, you (read: highly competent saver who did everything right) find yourself with more IRA/401K than you have bankable lifetime. You have 2 bad choices:

• Distribute from the IRA at a faster rate than you were hoping for, into other investments -- pushing yourself into the same tax bracket you were in while you were working.
• Fail to distribute enough from the IRA while you are healthy, and start having medical problems that necessitate distributing at a very high rate - pushing yourself into an even higher tax bracket than when you were working.

The cure for all these problems is Roth. With a Roth, the taxes are pre-paid, so the large withdrawals have no effect.

Take the free money anyway

Even so, the 50% FREE MONEY is way, way more than enough to pay those awkward taxes five times over and then some. So a traditional IRA/401(K) with a 50% match is still a better deal than a Roth anything with no match.

Seek the best of both worlds: Take the 401K with match, then convert to Roth 401(K) at some happy future date, e.g. in the event you take a gap year.