How much do you put into your 401k?

Right now I'm at 11%, but with equities getting so high, and I definitely have a fear of heights this extreme, I feel like I'm better off getting the cash.

Thoughts?

My company only matches up to 4% so was thinking of dropping to 5%.

Note: if you cold list seniority (analyst 1, analyst 2, associate 1, vp 1, etc;) I think that would extremely helpful.

 
Best Response

You should definitely keep putting in 11%. I actually recommend 15% if you can manage it, and don't hit the contribution cap although you're basically covering that with the employer match.

I get it, equities are expensive. And socking money away that you could spend elsewhere is a real drag.

You have alternatives. Most 401ks offer bond indices or bond funds, or better yet, inflation adjusted securities. Some offer resource equities if you're worried about inflation. Most offer an international portfolio if you're worried about realDonalTrump risk.

But you need to be socking away money for retirement, and a 401k is a vehicle that gives you access to tax-free returns.

Let's say you screw this up ala the credit crisis, where the market dropped about 40% between September 2008 and March 2009 (worst case). The tax savings from avoiding 15% capital gains taxes on 10% average returns over the next 40 years eclipses that loss. That's assuming you stick everything in equities rather than bonds.

If you're worried, consider a portfolio of 30% cash/ 70% stocks rather than 100% stocks. But make sure you have the discipline to transfer that cash into equity once P/E ratios on the S&P get down to 14. But I'd keep contributing.

Finally, just as a tip, your 401k can be a vehicle for MBA or grad school savings if that is your plan. IRAs from converted 401ks (be careful-- you will pay a penalty if it is withdrawn directly from a 401k) allow a penalty-free withdrawal to pay for school expenses and tuition. The cool thing is that if you do a FT MBA, you won't be earning any money, so the taxes you pay on the withdrawal will be a lot lower than your top marginal rate right now (I'm assuming you have a job that gets you into the 25% tax bracket, or about $40-50K/year). Furthermore, school tuition may be fully deductible (subject to AMT) as a business expense if you work full time for at least a year or two prior to grad school and remain in the same industry before and after graduate school (Ref IRS Pub. 970).

So if you plan on grad school at some point, I'd definitely keep contributing-- I'd just make sure the contributions went into cash or other conservative investments.

Good luck to you.

 
mpat215:

By P/E Ratio are you referring to forward or trailing sp500? Thanks.

Given that we're somewhere in the 20s right now, it's a very rough guideline-- pick one. Everyone can agree on the P in S&P P/E, but depending on which site you go to, whether you exclude losses, what kind of income you measure, the E can vary by a good 10-15%.

Stocks are always going to look a bit more expensive if you measure by trailing PE in a growing economy, and analyst biases tend to overestimate earnings, so forward PE always makes stocks look cheaper than they really are. But the historical ex-post average (that is, actual earnings that quarter divided by actual price) is about 14.

 
IlliniProgrammer:

You should definitely keep putting in 11%.

I get it, equities are expensive. And socking money away that you could spend elsewhere is a real drag.

You have alternatives. Most IRAs offer bond indices or bond funds, or better yet, inflation adjusted securities. Some offer resource equities if you're worried about inflation. Most offer an international portfolio if you're worried about realDonalTrump risk.

But you need to be socking away money for retirement, and a 401k is a vehicle that gives you access to tax-free returns.

Let's say you screw this up ala the credit crisis, where the market dropped about 40% between September 2008 and March 2009 (worst case). The tax savings from avoiding 15% capital gains taxes on 10% average returns over the next 40 years eclipses that loss. That's assuming you stick everything in equities rather than bonds.

If you're worried, consider a portfolio of 30% cash/ 70% stocks rather than 100% stocks. But make sure you have the discipline to transfer that cash into equity once P/E ratios get down to 14. But I'd keep contributing.

Finally, just as a tip, your 401k can be a vehicle for MBA or grad school savings if that is your plan. IRAs from converted 401ks (be careful-- you will pay a penalty if it is withdrawn directly from a 401k) allow a penalty-free withdrawal to pay for school expenses and tuition. The cool thing is that if you do a FT MBA, you won't be earning any money, so the taxes you pay on the withdrawal will be a lot lower than your top marginal rate right now (I'm assuming you have a job that gets you into the 25% tax bracket, or about $40-50K/year). Furthermore, school tuition may be fully deductible (subject to AMT) as a business expense if you work full time for at least a year or two prior to grad school and remain in the same industry before and after graduate school (Ref IRS Pub. 970).

So if you plan on grad school at some point, I'd definitely keep contributing-- I'd just make sure the contributions went into cash or other conservative investments.

Good luck to you.

Great advice thank you. I'm currently in low 6 figues: 125-135k
 
IlliniProgrammer:

You should definitely keep putting in 11%. I actually recommend 15% if you can manage it, and don't hit the contribution cap although you're basically covering that with the employer match.

I get it, equities are expensive. And socking money away that you could spend elsewhere is a real drag.

You have alternatives. Most 401ks offer bond indices or bond funds, or better yet, inflation adjusted securities. Some offer resource equities if you're worried about inflation. Most offer an international portfolio if you're worried about realDonalTrump risk.

But you need to be socking away money for retirement, and a 401k is a vehicle that gives you access to tax-free returns.

Let's say you screw this up ala the credit crisis, where the market dropped about 40% between September 2008 and March 2009 (worst case). The tax savings from avoiding 15% capital gains taxes on 10% average returns over the next 40 years eclipses that loss. That's assuming you stick everything in equities rather than bonds.

If you're worried, consider a portfolio of 30% cash/ 70% stocks rather than 100% stocks. But make sure you have the discipline to transfer that cash into equity once P/E ratios get down to 14. But I'd keep contributing.

Finally, just as a tip, your 401k can be a vehicle for MBA or grad school savings if that is your plan. IRAs from converted 401ks (be careful-- you will pay a penalty if it is withdrawn directly from a 401k) allow a penalty-free withdrawal to pay for school expenses and tuition. The cool thing is that if you do a FT MBA, you won't be earning any money, so the taxes you pay on the withdrawal will be a lot lower than your top marginal rate right now (I'm assuming you have a job that gets you into the 25% tax bracket, or about $40-50K/year). Furthermore, school tuition may be fully deductible (subject to AMT) as a business expense if you work full time for at least a year or two prior to grad school and remain in the same industry before and after graduate school (Ref IRS Pub. 970).

So if you plan on grad school at some point, I'd definitely keep contributing-- I'd just make sure the contributions went into cash or other conservative investments.

Good luck to you.

Very helpful post. If this road doesn't work out, I'm considering b-school or med-school. Instead of cutting to 5% I've raised the contribution to 13%.

 

dude, you should run a podcast on WSO called "The Rusty Honda" and talk about all the ways to be frugal/save money, etc... you could interview other owners of top finance blogs out there and WSO could make it popular fast :-)

We're getting into the Podcasting game very soon (sneak peak on where they will live: http://www.wallstreetoasis.com/podcasts) and I think your unique voice would be an awesome addition to the lineup.

will email you more details! Patrick

 

dude, you should run a podcast on WSO called "The Rusty Honda" and talk about all the ways to be frugal/save money, etc... you could interview other owners of top finance blogs out there and WSO could make it popular fast :-)

We're getting into the Podcasting game very soon (sneak peak on where they will live: http://www.wallstreetoasis.com/podcasts) and I think your unique voice would be an awesome addition to the lineup.

will email you more details! Patrick

 

employer match does not count toward contribution cap.

also pretax contributions are not tax free returns, it's tax deferred returns. roth is technically if you wait til retirement age/meet exceptions, but you pay tax on contributions up front.

also many allow for hardship withdrawals for school, home, medical bills and loan provisions where you pay yourself interest, although you pay the loan back at an after tax rate.

IlliniProgrammer:

You should definitely keep putting in 11%. I actually recommend 15% if you can manage it, and don't hit the contribution cap although you're basically covering that with the employer match.

I get it, equities are expensive. And socking money away that you could spend elsewhere is a real drag.

You have alternatives. Most 401ks offer bond indices or bond funds, or better yet, inflation adjusted securities. Some offer resource equities if you're worried about inflation. Most offer an international portfolio if you're worried about realDonalTrump risk.

But you need to be socking away money for retirement, and a 401k is a vehicle that gives you access to tax-free returns.

Let's say you screw this up ala the credit crisis, where the market dropped about 40% between September 2008 and March 2009 (worst case). The tax savings from avoiding 15% capital gains taxes on 10% average returns over the next 40 years eclipses that loss. That's assuming you stick everything in equities rather than bonds.

If you're worried, consider a portfolio of 30% cash/ 70% stocks rather than 100% stocks. But make sure you have the discipline to transfer that cash into equity once P/E ratios on the S&P get down to 14. But I'd keep contributing.

Finally, just as a tip, your 401k can be a vehicle for MBA or grad school savings if that is your plan. IRAs from converted 401ks (be careful-- you will pay a penalty if it is withdrawn directly from a 401k) allow a penalty-free withdrawal to pay for school expenses and tuition. The cool thing is that if you do a FT MBA, you won't be earning any money, so the taxes you pay on the withdrawal will be a lot lower than your top marginal rate right now (I'm assuming you have a job that gets you into the 25% tax bracket, or about $40-50K/year). Furthermore, school tuition may be fully deductible (subject to AMT) as a business expense if you work full time for at least a year or two prior to grad school and remain in the same industry before and after graduate school (Ref IRS Pub. 970).

So if you plan on grad school at some point, I'd definitely keep contributing-- I'd just make sure the contributions went into cash or other conservative investments.

Good luck to you.

If the glove don't fit, you must acquit!
 
WalMartShopper:

employer match does not count toward contribution cap.

Yes. I'm not sure I said differently, although it might be reasonable for others to read it that way. My point is that if you can hit the 15% target by contributing 15% yourself or 6% yourself, 9% your employer, it's pretty close to the same thing at the end of the day, at least
also pretax contributions are not tax free returns, it's tax deferred returns. roth is technically if you wait til retirement age/meet exceptions, but you pay tax on contributions up front.
Agreed, but it compounds tax-free. You get taxed once and that's it. Not twice as you would in a taxable account (once as ordinary income, and then another 15%, 18.8%, or 23.8% on the capital gains). Pre-tax money gives you all kinds of options including a Roth conversion.
also many allow for hardship withdrawals for school, home, medical bills and loan provisions where you pay yourself interest, although you pay the loan back at an after tax rate.
I believe you're referring to a 401k loan. I also believe that if you quit to go to school at some point, the loan must be repaid. I personally am not a fan of 401k loans unless you're desperate for cash-- the "if you get fired, repayment is due very quickly or it's a distribution with taxes and a 10% penalty" feature is a ticking time bomb.

You CAN do a withdrawal from an IRA for tuition and fees or for $10k towards a first-time home purchase. The money has to be rolled over from a 401k to an IRA first.

 
makemoneymakemoney:

This post awesome. Quick question though, if one can manage it, should they still hit the contribution cap? I've been doing 21%. Is this something I should reconsider?

labanker (below) brings up a reasonable counterargument. If you see yourself doing a startup or a small business, and if you don't plan on getting an MBA or going to grad school, and if you don't have a brilliant tax lawyer, it's helpful to have money outside of a retirement account.

First thing I'll tell you is that I'd make Roth IRA contributions before maxing out my 401k unless you're 100% certain you're going to grad school. The Roth IRA is especially valuable if your 401k contributions are pushing you into the 25% tax bracket, below $91K in taxable income.

Second point-- it's good to have six to twelve months of emergency savings.

Third thing I'll tell you is that if you're planning on eventually buying the kind of condo you're currently renting, make sure you're saving for a downpayment too. In fact, the advantages of owning your own condo with a 25% downpayment or house with a 20% downpayment may outweigh having money in a retirement account.

The best thing I can do here is be humble. This is a tough call and I don't have all of the answers. Some of this depends on your own situation and your own preferences and views. And tax law can change. The best I can do is point out some of your options and some of the avenues you have for saving and investing. But in any case, what I really want to tell you is that I'm happy about the fact that you are saving 21% of your income. I don't know your exact situation, but I also think it's even more commendable if 21% is $21,000 or smaller rather than $42,000 or bigger.

If it's reassuring, this isn't a clear and obvious decision for me given what I have in front of me right now, so my suspicion is that your expected value from one choice or another doesn't change too much. In other words, I'm not sure you can screw this up terribly.

In any case, if you have the discipline and foresight to save 21% of your income, especially if it requires a significant sacrifice on your part, something tells me you'll make the right decisions on this (with the information in this thread)-- better decisions than those I could make for you.

 

This actually appears not to be the case since income put into 401(k)s is treated as deferred income rather than capital gains regardless of where it is invested. Long term capital gains tax rates apparently do not apply to income from 401k investments. https://finance.zacks.com/should-401k-capital-gains-taxes-paid-8675.html

As such, it's worth asking the question of whether someone would be better off: 1. Maxing out 401(k) contribution 2. Maxing out 401(k) contribution matched by your employer and putting the rest of your savings into a personal account invested in an etf or something

In the second case, you'd have less money accumulating initially but pay about half the taxes when everything is sold assuming you're in the top income bracket by retirement. Interested in others' thoughts since I'm too lazy to do the math right now, but what one should do may depend more on age of contributions, etc than just maxing out one's contribution each year

 

"If you're worried about equity valuations, drop the percentage that you allocate to equities and direct toward another asset class. "

Like what? yields on fixed incomes are supposed to continue to increase, which is nothing more than a function of a decrease in their price. So reallocating to fixed income securities is not particularly inviting.

Raising interest rates (higher cost of debt) have an adverse affect on any asset that is partially funded by debt - so i would imagine real estate gets hammered.

Protectionist policy promogulated by the current administration makes foreign equities scary too.

I am by no means an expert on any of the subjects above, but based on my basic understanding of finance, I cant imagine where the "smart money" is right now. Then again, investors have to put there money somewhere, no?

 
Brosef Stalin17:

"If you're worried about equity valuations, drop the percentage that you allocate to equities and direct toward another asset class. "

Like what? yields on fixed incomes are supposed to continue to increase, which is nothing more than a function of a decrease in their price. So reallocating to fixed income securities is not particularly inviting.

That's a legitimate point. I would not have given this advice when the 10 year was at 1.7% but we're up 75 basis points since November. 5-10 year BBB bonds are yielding 4%. If yields go up 50 basis points over the next 15 months, you still break even with bonds that carry an OAD of 10. Obviously if you expect interest rates to go up 100-200 basis points fairly quickly you'd want to wait. But I can price in rising rates and still make a case for bonds.

For those of us with IRAs, Andrews Federal Credit Union offers a 3% 7-year CD with a 6 month early withdrawal penalty. If you like your rate- you can keep it. If there's a better rate, pay the 1.5% early withdrawal fee and reinvest at 4% or 5%.

Raising interest rates (higher cost of debt) have an adverse affect on any asset that is partially funded by debt - so i would imagine real estate gets hammered.

Protectionist policy promogulated by the current administration makes foreign equities scary too.

I am by no means an expert on any of the subjects above, but based on my basic understanding of finance, I cant imagine where the "smart money" is right now. Then again, investors have to put there money somewhere, no?

With Trump running around, do you want it all in the US Dollar either?

I'd stick my money in the equities markets of traditional US allies- Canada, UK (I know, Brexit, but that ugliness is priced in), Australia, etc. Our allies will get access to US markets and developing markets and avoid Trump volatility. The EAFE is a halfway decent proxy if your 401k only gives you a 20-choice menu.

You could also put it in gold. Counterintuitively, gold is actually agnostic to rate-hike cycles. In fact, it's gone up in roughly half of the full rate hike cycles since the US exited Bretton Woods in 1971.

 

please elaborate on protectionist policies making foreign equities scary? i didn't realize the entire world's market correlates to US.

Brosef Stalin17:

"If you're worried about equity valuations, drop the percentage that you allocate to equities and direct toward another asset class. "

Like what? yields on fixed incomes are supposed to continue to increase, which is nothing more than a function of a decrease in their price. So reallocating to fixed income securities is not particularly inviting.

Raising interest rates (higher cost of debt) have an adverse affect on any asset that is partially funded by debt - so i would imagine real estate gets hammered.

Protectionist policy promogulated by the current administration makes foreign equities scary too.

I am by no means an expert on any of the subjects above, but based on my basic understanding of finance, I cant imagine where the "smart money" is right now. Then again, investors have to put there money somewhere, no?

If the glove don't fit, you must acquit!
 
dinoRE:

I like to average it out long term... during higher valuations like now ill do a little less like 5-10%... but when the market goes south or there's a recession I max it out.

That was my initial thought. I budget quite well, so I know I could go up to about 18% while still being able to cover all my expenses and live the life I am living.

 
dinoRE:

I like to average it out long term... during higher valuations like now ill do a little less like 5-10%... but when the market goes south or there's a recession I max it out.

I argue that this may not be the right way to think about it, at least if the amount you're contributing each fiscal year is changing.

To be sure, there are cases where having money in a 401k will be painful. Like having a job loss and needing cash. But if you have a 401k with multiple investment options like most people, you should be trying to max it out along with your Roth or at least contributing roughly the same amount each year. If you think the market is too expensive, stick more money into cash or bonds in your 401k.

Why?

Cash in that account is an option on buying in a tax-free account at the bottom- and never having to worry about the compounding of capital gains tax.

Every year you miss out on a retirement account contribution is a year permanently gone. When December 31st 2016 rolled over to January 1st, it became impossible to make a FY 2016 contribution to a 401k with FY 2016's $18,000 cap. So when the market bottoms-- and let's say it's 2019, you can pour money in if you want-- but you'll get capped at $18K. But meanwhile if you'd been contributing money before then and leaving it in bonds, or foreign stocks, or cash, all of those contributions you made in 2016 and 2017 can be poured into the market at bottom.

Now as for me, I try and change the investments my contributions go into. In a cheap market, I'd be 80% equity, 20% cash/bonds. In our current environment, I'm contributing more like 65%/35%. I know the market's expensive, but over a long period of time, I'll still make money on the equity I buy. And when the bottom hits, I'll have some dry powder to buy with.

 
Trainer:

Just a clarifying question.... when referring to 401(k) contributions, is it proper to mention your total contribution (employee contribution + company match) or just your personal contribution?

So when OP refers to his contribution of 11%, is that just his contribution? Or inclusive of employer match?

Just mine. Employer matches up to 4%, so it is essentially 15% in total.

 

This isn't strictly related to 401ks, but while we're on the topic of personal finance, I recommend putting your non-retirement-account cash into I bonds:

http://blogs.wsj.com/experts/2015/03/03/why-more-investors-should-be-bu…

They basically earn interest at the rate of inflation (2.76% now) and will not lose their face value when rates rise like TIPS do. The interest rate also never goes below zero in deflationary periods. You buy direct from the Treasury, so there are no transaction costs. Most financial advisors won't tell you about them. It's a great way to inflation-protect your cash.

The only catch is you have to lock up your money for a year, and redemption within five years means you forfeit interest from the last three months (not very much at this point). This is still a much better deal than any CDs and money market funds out there. Heck, intermediate-term investment-grade bonds (VFIDX) are yielding slightly less and they have interest rate risk!

There's a $10k/person/year contribution limit, but you can use proceeds from a tax refund to go above this limit. I've been building a ladder of these for my emergency fund and cash I'm going to use opportunistically to buy stocks or real estate during the next downturn.

 
BananaRepublic:

This isn't strictly related to 401ks, but while we're on the topic of personal finance, I recommend putting your non-retirement-account cash into I bonds:
http://blogs.wsj.com/experts/2015/03/03/why-more-i...

They basically earn interest at the rate of inflation (2.76% now) and will not lose their face value when rates rise like TIPS do. The interest rate also never goes below zero in deflationary periods. You buy direct from the Treasury, so there are no transaction costs. Most financial advisors won't tell you about them. It's a great way to inflation-protect your cash.

The only catch is you have to lock up your money for a year, and redemption within five years means you forfeit interest from the last three months (not very much at this point). This is still a much better deal than any CDs and money market funds out there. Heck, intermediate-term investment-grade bonds (VFIDX) are yielding slightly less and they have interest rate risk!

There's a $10k/person/year contribution limit, but you can use proceeds from a tax refund to go above this limit. I've been building a ladder of these for my emergency fund and cash I'm going to use opportunistically to buy stocks or real estate during the next downturn.

Technically it's 11 months if you buy on the 31st and cash them in on the first.

They also have some nice tax deferral features.

 

6% /w 4% company match. That's the maximum amount I can contribute that results in some sort of company match.

I would do more, but saving for a house down payment (rental market in my area is exorbitantly high compared to housing prices, so for once buying is actually the cheaper option if you can afford the down payment). After that I'll likely supplement with a maxed out IRA every year.

 

You should put in zero.

Yep. Zero.

"But...but...my firm matches 2% up to $3,000! and all my returns are tax deferred! and my plan has options like the Fidelity Triple Income Ultra Plus Fund! and that guy on TV says I need to start contributing now if I want be able to pay for my diabetes medicine when I'm 70 and be there for all of life's special moments!"

Forget all that stuff. You have one goal finance-wise from ages 22-35: build a war chest of cold, hard cash. Around your early to mid 30s you'll likely want to start making some real moves and take advantage of some real opportunities. Make sure you have the requisite table stakes to do so.

Do that and retirement will take care of itself.

 
labanker:

You should put in zero.

Yep. Zero.

"But...but...my firm matches 2% up to $3,000! and all my returns are tax deferred! and my plan has options like the Fidelity Triple Income Ultra Plus Fund! and that guy on TV says I need to start contributing now if I want be able to pay for my diabetes medicine when I'm 70 and be there for all of life's special moments!"

Forget all that stuff. You have one goal finance-wise from ages 22-35: build a war chest of cold, hard cash. Around your early to mid 30s you'll likely want to start making some real moves and take advantage of some real opportunities. Make sure you have the requisite table stakes to do so.

Do that and retirement will take care of itself.

At minimum, take the match.

 
labanker:
Around your early to mid 30s you'll likely want to start making some real moves and take advantage of some real opportunities. Make sure you have the requisite table stakes to do so.

I tend to agree but here's the way I look at it (anyone more knowledgable feel free to correct where I'm wrong).

For some simplified example, making 100k with 5% match. You always pay the match (but no more) every opportunity for 5 years. 10k for 5 years= 50k. Take it out and just eat the penalty (10%?) so 45k. Taxes are moot to this discussion since the only variable is timing. So that's 25k in and 45k out for a non-return dependent, 20k. I too would have no interest in putting money somewhere I couldn't see it until retirement, but my understanding is it's worth it even with no intention of waiting.

 
labanker:

You should put in zero.

Yep. Zero.

"But...but...my firm matches 2% up to $3,000! and all my returns are tax deferred! and my plan has options like the Fidelity Triple Income Ultra Plus Fund! and that guy on TV says I need to start contributing now if I want be able to pay for my diabetes medicine when I'm 70 and be there for all of life's special moments!"

Forget all that stuff. You have one goal finance-wise from ages 22-35: build a war chest of cold, hard cash. Around your early to mid 30s you'll likely want to start making some real moves and take advantage of some real opportunities. Make sure you have the requisite table stakes to do so.

Do that and retirement will take care of itself.

Your IRA can invest in a small business. Including your own business, I believe. You have to be careful not to trigger a distribution-- which can happen if the terms aren't set at arms' length, but I think there are companies out there that can do this for you.

http://guides.wsj.com/small-business/funding/how-to-tap-an-ira-or-401k-…

 

Actually I'd recommend contributing up to the max that your company matches (4 percent). The rest of your pay that you are putting in (remaining 7 percent), you should put after tax dollars in the same mutual funds in a Roth IRA. That way your withdrawals from your Roth are exempt from federal tax withholding. Plus your returns grow tax free, rather than tax deferred like in a 401k.

 

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