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Should I Contribute More To My 401k?

You may already know that you should contribute as much to your 401k plan as your employer will match. But when is it time to increase your 401k contributions? And how do you decide between adding more to your 401k or funding an IRA?

Should I contribute more to my 401k?One of the most common questions we get asked by budding investors is how much they should contribute to their 401k plan; more specifically, should they be contributing more?

For most, the 401k is going to be a first introduction into retirement planning, and you want to make sure you’re doing everything you can with that before tackling things like mutual funds and brokerage accounts on your own.

There’s no one right answer. It really depends on your tax bracket, the amount your employer contributes and your discretionary income, but you will likely identify with one of those categories.

First, max out your match

Let’s start with the obvious: Are you contributing up to the maximum percentage that your employer matches in your 401k? If not, that’s the first thing you need to address. There’s no better bargain than someone else matching your investment funds dollar for dollar.

But let’s say you are taking advantage of the full match – in most cases it will represent between 3 and 5 percent of your annual salary – what’s the next step?

If you’re eligible, look at a Roth IRA

Two big drawbacks to 401k plans are the limited investment choices they give to you and the fees some charge. IRAs and Roth IRAs offer much better fund options and allow you to diversify and manage your risk tolerance — and the fees you pay — more efficiently.

You have probably heard that a Roth IRA is a better plan than a traditional IRA, but may not know why. It’s simple: Traditional IRAs allow for an up-front tax deduction, but tax you on the back end when you withdraw funds whereas the Roth IRA taxes you now, thus allowing you to withdraw tax-free when you hit retirement age. Since you will most likely be in the workforce for the next 25 plus years, your income is at the lowest level of your career so paying taxes now isn’t much of a burden.

Sounds great, right? Why wouldn’t everyone just get a Roth IRA after hitting their 401k match?

Believe it or not, there is such a thing as making too much money – as far as the IRS is concerned anyways. As of 2016, if you’re single making more than $132,000 per year or married making more than $194,000 per year, you are no longer eligible to contribute to a Roth IRA. Bummer. But hey, with that extra income (if you’ve been vigilant in your lifestyle) you now have more discretionary income available.

If not, keep pumping the 401k

Back to square one — you have two possibilities for investment contributions: IRA or 401k. Even though the 401k has fewer investment choices available, it’s still the better deal.

The IRA will always allow tax-deferred growth in the account, you’ll pay those taxes when you withdraw, but it might not give you an upfront tax deduction anymore. The 401k will still invest your money pre-tax even though your employer won’t match the extra you put in there. The 401k also has much higher contribution limits – $18,000 as of 2016 versus $5,500 for an IRA.

Let’s do a quick recap:

  • Make 401k contributions up to maximum employer match
  • Determine whether you can contribute to a Roth IRA
  • If yes, contribute up to maximum allowable amount ($5,500) to Roth IRA
  • If no, contribute more to your 401k until you max out at $18,000 annually

Some employers offer a Roth 401k to employees, but the same rules apply as with the Roth IRA. You should contribute as much as you can to the Roth accounts first unless you exceed the income limitations placed on them by the IRS. Another thing to keep in mind is that IRAs can be converted to Roth IRA accounts at any time, although you will not be able to place any additional funds into the Roth once it’s converted over. You’ll have to pay taxes to convert the retirement accounts over, but then the funds can be withdrawn tax-free once you hit the retirement age of 59 ½.

Published or updated on September 9, 2013

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About Daniel Cross

Daniel Cross has been in the industry as an investment writer and financial advisor since 2005. He holds the Chartered Financial Consultant designation (ChFC) as well as Series 7 and Series 66 licenses, and has embarked on the arduous journey of obtaining the coveted CFA designation. Daniel lives in Florida with his wife, daughter, and pet Tortoise ironically named Turbo.


We invite readers to respond with questions or comments. Comments may be held for moderation and will be published according to our comment policy. Comments are the opinions of their authors; they do not represent the views or opinions of Money Under 30.

  1. Adam Porter says:

    I had been contributing 10% to my 401(k), but because of part ownership in the family business, I got scaled back to a 6% maximum. Thankfully, that’s still above the company match level. Apparently, there’s a law governing the balance of contributed funds between owner and non-owner employees. That was news to me!

    In any case, it just means my Roth IRA can get fatter a little more quickly.

    Thanks for the guidelines. That’ll help me divert money as situations change in the future.

  2. Brian says:

    Why no recommendation of the back-door Roth contribution for those above the income maximum. Contribute to a traditional IRA and immediately convert it to a Roth.

    • Daniel Cross says:

      You certainly could, but keep in mind you won’t be able to contribute any more to that Roth once you convert. If you’re trying to save on a monthly basis that wouldn’t work out logistically.

  3. Susanna says:

    I have a question about investing in a traditional 401k versus a Roth IRA. I have already matched my employer contributions in the traditional 401k and am considering whether I should invest more in the 401k or move over to a Roth IRA. From what I gather, I would pay taxes up front on contributions to a Roth IRA and then will not have to pay taxes on the income I take from the IRA when I retire. This seems like a good deal if I think I will have to pay higher taxes in the future based on the fact that my income will probably be higher than it is now when I retire. The question is, in retirement, I will only be withdrawing from 401k and whatever other investment accounts I have for income, which I doubt will be higher than my income now. Thus my taxable income in retirement will be much lower. With this in mind, is it worth it to forego the compound interest I will earn on that amount I would have paid up on taxes on Roth IRA contributions, which I could continually invest in my 401k?

    • cj says:

      Well, I don’t have an answer to your question, but the other piece of this math problem is that with a Roth IRA you won’t pay any taxes on all the interest you earn on your investments, while with a 401K you will be paying taxes on the money you put in as well as all the growth over all those years. This would require a spreadsheet analysis to figure out, but what I alluded to above would indicate that it might be more worth it to do the Roth IRA earlier than later, since the more years for growth that won’t be taxed, the more benift you’d get from it.

    • Daniel Cross says:

      I think my response to Lucas (above) should answer your question as well.

  4. Lucas says:

    Roth is important for anyone thinking of retiring early. But tax wise it is hands down worse then the Traditional Roth by a long shot!!

    Total tax burden on a ROTH IRA = marginal tax rate at time of contribution
    Total tax burden on Traditional IRA = Average tax rate at time of withdraw.

    The difference between Margin and Average tax rates is huge!! For me my marginal rate right now is like 23% (federal + State), but my average is only 7% (federal + state). In retirement I expect to make much less (and I haven’t heard about anyone who doesn’t yet), so your average rate ends up going down as well.

    If you want more on this, i just had a debate in the comments on this other blog: http://www.welfaretowelloff.com/roth-iras-are-stupid-for-your-family-heres-why/

    Also you forgot to mention HSAs – they are better then a ROTH and 401k combined (after matching money in 401k). You pay no taxes going in, you pay no taxes going out, and you get social security and medicare tax off as well if it is done through a payroll deduction!!!!

    • Daniel Cross says:

      Tax rates are subject to changes and trying to predict the tax code 20 plus years out wouldn’t be fiscally responsible for any financial planner. That being said, there is a greater benefit to paying taxes now and allowing that money to grow not just tax deferred, but tax free when you withdraw in the case of a Roth IRA. If you invest $10,000 and pay 30% in taxes, $7,000 will grow over 20 years at 8% to be over $32,000 that can be taken out completely tax free. If you invested $10,000 into a traditional IRA, you would be taxed on all $32,000. Even if you halved the tax rate to 15%, you’ll end up paying out nearly $5,000 in taxes versus $3,000.

      • Susanna Wang says:

        Roth IRA: $10K with 30% in taxes, $7K in account. Assuming 8% interest annually compounded for 20 years, 7000(1.08)^20 = $32626. Taken out tax free.

        401K: $10K with 0% taxes, $10K in account. Assuming 8 % interest annually compounded for 20 years, 10000(1.08)^20 = $46609. Taken out at an assumed 15% tax would yield $39617.

        Sure you are paying $3K in taxes initially with a Roth IRA and about $7K with a 401k, but due to the greater effects of compound interest with a 401k on an untaxed balance, your account would yield more.

      • Mark says:

        You might want to run your numbers again, $10K going into a Roth is not the same as $10K going into a Traditional IRA/401K.

  5. Mike says:

    I was originally contributing enough to get my employer match (5% in my case), and I also contribute $5,500 my Roth IRA. However, for the past two years, I have been maxing out my 401k (the full $17500). Is that a good strategy, or should I instead invest some in a taxable (non-retirement) account?

    In other words, am I investing too much in 401k, and tying up too much money that I can’t touch until retirement?

    • cj says:

      One thing you could look into is whether you can take out a loan on your 401K for something like a house purchase (many programs allow this). If so, saving the max into the 401K may be a great way to save for a house pretax. But the things to keep in mind when loaning from your 401K is to make sure you would be able to afford the loan repayment to the 401K, plus any minimum contribution for matching, and also to consider the diversification of your retirement portfolio if you take a big chunk out for a home loan.

    • Daniel Cross says:

      You might want to consider talking to a financial advisor for a more in depth conversation about this because there are many elements that need to be taken into consideration. It sounds like you need a comprehensive financial plan that incorporates retirement savings along with emergency savings. You should have several months worth of savings set aside to give yourself some liquidity in case of an emergency, but keep in mind goals like buying a house will require a separate savings plan altogether.

      • Mike says:

        I’ve already bought a modest house with a 30 year at 3.5%, and I also have a well stocked bank account that I can survive on for more than a year.

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