Two of the most popular vehicles to save for retirement are 401(k) plans and IRAs. In order to reap the maximum benefit from both types of plans, you may need to rethink how you allocate your savings between the two. At Henssler Financial, our preferred savings strategy is designed to maximize your after-tax return and investment flexibility.
If you are able to maximize your contribution to both your 401(k) plan and your IRA, we recommend you do so. If you are unable to save the maximum permitted, the preferred contribution sequence and allocation of investible funds is:
- Maximum allowed for 401(k) with employer match
- If you qualify, $5,000 into Roth IRA
- Balance of allowable amount for 401(k)
- After having saved as directed above and you did not qualify for the Roth IRA or traditional deductible IRA, you may contribute $5,000 to a traditional nondeductible IRA
Example:
Joe, 45 years old, receives a salary of $100,000 per year from his employer, which offers a 401(k) plan that matches 50% of the first 6% of the employee’s contribution and allows a maximum of 14% to be contributed by each employee. Joe can afford to save a total of $18,000 in his combined 401(k) and IRA accounts for him and his wife Jill.
Our recommended savings strategy is: 6% or $6,000 employee contribution into his 401(k), causing the employer to contribute $3,000. Then a $5,000 contribution into a Roth IRA for Joe and $5,000 into Roth IRA for Jill. Finally, an additional 2% or $2,000 employee contribution into his 401(k), which brings us to the targeted $18,000 for savings.
Possible Exceptions:
Minimizing Taxes
If your highest priority is minimizing taxes in the year of the IRA contribution vs. future tax-free withdrawals, you may want to choose a traditional deductible IRA (if you qualify) instead of a Roth IRA. NEVER choose a traditional nondeductible IRA over a Roth IRA.
If You Do Not Like Your 401(k) Options
If you do not like the investment options in your 401(k) plan, we still suggest contributing the maximum allowed to obtain the employer match. The employer match creates an immediate return on your contribution that is too good to forfeit. Then you should make a $5,000 contribution to a Roth IRA or Traditional deductible IRA. You would then proceed to contribute the balance of your allowable amount into your 401(k) plan investing in the best option of what is offered.
Pre-Tax vs. Post-Tax 401(k) Contributions
If your employer allows pre-tax and post-tax 401(k) contributions, follow the same sequence as documented above with the following approach to 401(k) contributions. In most cases, if there is a limit on the amount you can afford to invest, we recommend using up the pre-tax allowable amount first and if you can invest more after that, use the post-tax contribution category. Using pre-tax first allows you to save a greater percentage in the 401(k) and still receive the same after-tax amount in your pay check.
When to Call it Quits
With all this saving, you may be asking yourself when you can “call it quits” and retire. The answer is simple: When you have enough assets to achieve “financial independence.” In other words, when you have enough assets to support the lifestyle you desire without continuing to work.
It does not necessarily mean that you quit working, only that you don’t need to work. A lot of successful, financially independent people choose to work because it is something they enjoy.
Bottom Line
At Henssler Financial, we feel that the combination of a 401(k) and a Roth IRA will help maximize your return, while still maintaining some investment flexibility. If you are still unsure of how much to allocate or how long to save, we can help you determine the appropriate amount with the use of a proprietary cash flow model. This cash flow pinpoints when you have acquired enough assets to last for through your retirement. For more information, contact our experts at 770-429-9166 or experts@henssler.com.