401(k) Contribution When Employer Has No Match?

Question

Long time lurker, first time asker here. I've seen some similar questions to mine here, but nothing exactly in the same circumstance.

I've seen almost near-consensus that the ordering for investing should be as so:

1. Fund an employer's 401(k) up until the point that you get the most out of their match.
2. Fund a Roth IRA until you hit the yearly maximum.
3. Fund your 401(k) until you reach that maximum.
4. If you have further cash to invest, you have to put it in an account that is not tax-sheltered.

Right now, I'm contributing 10% of my paycheck to the company-sponsored 401(k), but the company does not offer any sort of match right now, but it is planned to resume in the near-future. Given that there is no match, I was wondering if it would be a better idea suspend or reduce the amount I'm contributing to the 401(k) and move that into another investment vehicle, like a Roth IRA. I also have the option in my 401(k) plan to put a portion of my money in a Roth 401(k).

I'm currently 22 and have no major debts --just daily expenses put on a credit card, which is always paid off at the end of the month. I'm in the US.

Answer 1

I think you're doing the right thing. One of the benefits of tax-deferred account, aside of it being tax-deferred, is that it keeps the money locked from you. Some people think it's a bad thing, I think it's a good thing. The amount of money locked is not that significant relatively to your income (10% in your case, which is a lot relatively to others of your age, and shows that you think ahead and plan for your future), but it builds up a cushion to fall to when you're old.

Many people don't think of the time they're old, or think they'll be the same or better (income-wise) as they're now. That is not so. Although during the period of your life your marginal tax will indeed grow, in the end it goes back down again for most of the people, and that is because your income goes down. It is then that you need the money you're putting aside now, and the more you put aside, and the earlier you put it aside - the more you will have then.

The fact that it's locked promises that you will have it then, not before when you want to buy a house you can't afford or impress a girl with a car you can't pay for.

In my mind that's the best benefit, and the fact that the earlier you start putting the money there, the more gains it will acquire until you actually need it.

So keep up the good work, and save for your future, lock out that 10%, and invest the rest in other channels which may be more risky and with more potential gains.

Answer 2

Let me throw in one more variable to consider.

Company 401K plans typically have MUCH higher fees than you are likely to get if you shop around on your own as long as you don't go with a high dollar broker. You won't see these fees on your statements typically, which I think is criminal, but they are hidden in the prices of the funds you are buying in the 401K.

If you don't believe me, get the quotes for a fund from the 401K company's web-site then look up the same fund on a site like MSMoney. The share prices won't match and you will be angry until you come to terms with it.

So if you have a choice of money in a personal retirement account versus a 401K always go with your own account... UNLESS:

• You aren't disciplined enough to keep investing that money every month without the ease of having it taken out of your paycheck automatically. (be honest with yourself).

or

• The company is matching, which you said they aren't. Free money will more than make up for the extra fees in almost all cases.

Answer 3

Since there is no match on the 401k, it seems to me that your first priority should be your IRA (Roth or otherwise).

I don't know what your salary is, but most 22 year-olds won't be maxing out both an IRA and 401k on only 10% of their incomes, so the rest of the list may be irrelevant.

Answer 4

I humbly disagree with #2. the use of Roth or pre-tax IRA depends on your circumstance. With no match in the 401(k), I'd start with an IRA. If you have more than $5k to put in, then some 401(k) would be needed.

Edit - to add detail on Roth decision. I was invited to write a guest article "Roth IRAs and your retirement income" some time ago. In it, I discuss the large amount of pretax savings it takes to generate the income to put you in a high bracket in retirement. This analysis leads me to believe the risk of paying tax now only to find tHat you are in a lower bracket upon retiring is far greater than the opposite. I think if there were any generalization (I hate rules of thumb, they are utterly pick-apartable) to be made, it's that if you are in the 15% bracket or lower, go Roth. As your income puts you into 25%, go pretax. I believe this would apply to the bulk of investors, 80%+.

Answer 5

Congrats on saving aggressively when you're young.

I'm not a huge fan of tax-advantaged accounts because the rules can change on them, and there's already a penalty for you to take out that money for most purposes until you've almost tripled your age.

Free money (a match) overcomes this reservation for me, but I'm not contributing anything beyond that. I'm paying my taxes on the rest and am done with them.

Watching your money grow tax-free for another 37 1/2 years only to see your (and everyone else's) marginal tax rate rise isn't much fun. I'm not saying that will happen, but it certainly could.

Answer 6

Didn't see it mentioned so far, but depending on modified AGI you may be prevented from a tax deduction for your contribution to a Traditional IRA if you or your spouse are offered a retirement plan at work, even if you don't participate in it. See the IRS page here for the details of deduction limitability: https://www.irs.gov/retirement-plans/2017-ira-deduction-limits-effect-of-modified-agi-on-deduction-if-you-are-covered-by-a-retirement-plan-at-work

In my opinion, because I heavily favor all the benefits of the Roth, I'd contribute first to a Roth IRA and then to the Roth 401(k). The former first because it puts the money in a place where you have more control over fees and how it is invested. The latter because the contribution limits are much higher than the IRA, and the money grows tax-free and incurs no taxes on withdrawal.

Answer 7

As some of the other answers pointed out, company 401(k) accounts can sometimes have poor investment choices so if the company isn't doing some sort of matching and you only have a limited set of options, I would likely recommend that you roll the money over to a different 401(k) account so you have better investment options. Why choice from tens of funds when you may have the full market worth of options as your disposal? Likewise, if you have electronic deposit you might be able to have the 10% automatically deposited to that account out of your paycheck so you will still be getting the advantage of having "forced savings" from a young age.

In regards to a Roth IRA, as others have pointed out, they are a bit of a gamble and you can't ensure that you will come out ahead at the end of the day in regards to taxes; however, you also need to take your own career goals into account when you make that decision. If you see yourself getting up there in the income bracket of the course of your career it doesn't hurt to have a Roth IRA now and start putting some money in it (limited amount though, maybe only $100 a month) but if you don't see yourself getting up that high in the income brackets then it might not be worth the overhead of having multiple accounts to keep track of.

That said though, make sure that you aren't just saving for retirement, you should have another savings account that you are putting money away for rainy days, houses, and the like.