Retirement Savings: 401k Matched, Roth IRA Maxed, Now What?

Financial planners occasionally squabble over whether or not to invest Roth IRA vs 401(k).  Most agree that passing up matching funds in a 401(k) plan makes little sense, so it’s probably best to start there.

After taking advantage of those matching funds by investing through the company match, it most advisers recommend investors turn to the Roth IRA to take advantage of tax free growth opportunities.  After that, you are on your own, and left with a lot of questions.  Do I return to the 401(k) plan and max out my annual contribution there?  Do I invest in company stock?  Do I park anything left over in cash, or single stocks?  Let’s take it one step at a time.

Invest In 401(k) Through Matching Funds

Let’s assume your company offers to match the first 3% of your annual salary if you contribute to the plan.  If you earn $50,000 a year, and agree to participate at a 3% contribution, your annual contribution amount will be $1,500.  Your employer will kick in another $1,500, bringing your total contribution each year to $3,000.  That $1,500 contribution from your employer is almost like free money (nothing is completely free – you will owe taxes on it when you withdraw it down the line).

Max Out Roth IRA Contribution For You and Spouse

If you are living frugal, and haven’t buried yourself in house and car payments, you can probably afford to kick in another few thousand dollars each year to saving for retirement. Assuming you are eligible to contribute to a Roth IRA, it probably makes sense to turn your investment dollars above your employer’s 401(k) match here.

Contributions to a Roth IRA won’t help with your taxes in the year they are made, but earnings grow tax free over the life of the investment.  If your $5,000 contribution this year turns into $40,000 by retirement, you get to keep all $35,000 growth tax free, assuming you withdraw after reaching retirement age, or for a narrow list of specified qualified withdrawals.

Another beauty of Roth IRAs investments is that Roth IRA withdrawal rules allow for the withdrawal of contributions without penalty, at any time.  So theoretically, you could park money in a Roth IRA to grow for three or four years, and then only withdraw contributions, leaving the earnings untouched and continuing to grow.

Max Out 401(k) Contributions or Taxable Investing

At this point you’ve invested in a 401(k) through the company match, and maxed out contributions to a Roth IRA for you and your spouse (if married).  If you still have money to invest for retirement you have a choice:  return to your 401(k) plan and invest up to your annual maximum contribution, or invest in non-retirement, taxable accounts.

The path you ultimately take here depends on your goals for the future, and your overall financial picture. Personally, I would begin to invest in low-cost, low-turnover, taxable investment vehicles such as a broad index fund.  I have plans to “retire” early from full-time employment, and to do so will need access to savings prior to the IRS-defined retirement age (currently 59 1/2). If I planned to work well past the currently defined retirement age, I would probably plow more money back into the 401(k) plan to lower my taxable income and defer those taxes to retirement.

If you do decide to invest in taxable accounts go with a low-cost brokerage such as Vanguard (which I happen to think is one of the best places for a Roth IRA) or Fidelity.  These brokerages are widely recognized as two of brokerages with the lowest expense ratios in the industry.  Inside those brokerages, look for mutual funds with low turnover.

Remember, each time an investment inside a mutual fund is sold or exchanged, or “turns over,” it is a taxable event.  Those taxes will be distributed to mutual fund owners at the end of the year, and can create quite a tax hit, even if your overall mutual fund performance is down.

If I had to pick one fund to invest in it would the Vanguard Total Stock Market Index fund, which owns a little piece of every stock listed.  As you can imagine, there is not a lot of buying and selling happening here, which minimizes your tax hit.  It is also about as diversified as one could get within the domestic equities market (the Total International Stock Index fund is the international investment equivalent).

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  1. I like the idea of index funds as well. They are easier to “buy and hold”, low cost, and — as you point out — have low turnover. Once you move on beyond your retirement account (and even in your retirement account), I like the idea of keeping things simple.

  2. I’m in the same position as you, minus the spouse, and I’ve been considering the Roth 401k option. I haven’t pulled the trigger yet since I’m still doing some research, but it’s looking promising. I’ll probably work on maxing that out before contributing anything else to my employer’s 401k (beyond what it takes to benefit from their match)

  3. How about diversify and get into Real Estate? It surely involves more work than the market, but consider that you get to depreciate the property for a tax savings (something that investing in the “glorious” market you can’t do), and harvest home office deductions, it’s a great option. Saved us $130k in taxes already… While we “still” have over $500k in the stock market which will grow (but pesky fees and taxes sucking down the growth). We bought $1.2M of houses purchased for $250k on 15 year fixed mortgages. That means our RE investment will be “fully funded” in 15 years, right about the time we retire with $9k a month from the rentals alone. 1031 to new units to avoid maintenance and we’re good to go for another 15 years. I have to laugh at these “stock market only” articles since they seem so myopic. While both the stock market has taken a 40 % tumble, only certain over-built areas have been hit that hard in the RE market. Not saying that RE is the only way to go, but at least it’s an option. And, right now, the prices are pretty good. The key is the tax advantage.

  4. One thing to consider with Vanguard and Fidelity is the cost of entry. If you are young, like me, and only have maybe $200/mo to put into an investment vehicle, it may be wise to look at Sharebuilder. ING’s Sharebuilder doesn’t require a minimum investment like Vanguard or Fidelity, so you can use Sharebuilder to build up to the minimum entry requirements for Vanguard.

    Just a thought for those in similar situations to me.

  5. So, I am new to investing, and plan on taking advantage of my company matching 401K, but I’m really interested in your statement about Roth IRA’s contribution withdrawals not incurring a penalty. Is that at ANY time, or only after 5 years?

    In addition, say I put $5k/yr into a Roth IRA, and I wait the 5-yr minimum, leaving me with 25k(investment) earnings. Are both the investment and earnings available for penalty-free withdrawal after 5 years?

    Secondly, in each scenario that I have read the example begins with someone rolling a traditional IRA into a Roth IRA. Does this ‘conversion’ play a role in whether the contributions can be withdrawn? Or can you do the same thing if you begin by initially investing directly into the Roth?

    I read on another site( “If you wait until after the five-tax-year period to withdraw money from a Roth IRA, the 10% penalty won’t be imposed, even if you aren’t yet 59 1/2 and don’t meet any other exception to the penalty.”

    This is a very confusing topic, so I like reading these articles.


  6. @Caleb: You make a great point. Vanguard and Fidelity do have a high minimum contribution requirement (I think it’s around $3k for Vanguard, per mutual fund selected). I would look at an online savings account or similar to build up enough to make this minimum contribution.

    Some brokerages will waive the minimum contribution if you agree to an automatic contribution plan (i.e. $50/month deducted from your checking account), but I don’t believe these two firms offer the waiver.

  7. @Jon: Disclaimer: consult an expert before making any moves where you might create a taxable event.

    My understanding is that Roth IRA contributions may be withdrawn at any time; that’s only your contributions. Earnings may be withdrawn after five years, but before 59 1/2, without penalty if you withdraw for one of a small number of exceptions (the purchase of your first home, etc.). After 59 1/2 you may withdraw both contributions and earnings tax free.

    Converting a traditional (deductible) IRA to a Roth IRA does have tax consequences, and muddies the water a bit. Typically, taxes are due in the year that you convert the funds because up to that point the money has not yet been taxed. Once taxes have been paid I would think the Roth IRA withdrawal policy would kick in as if it were a new Roth.

    Can anyone out there confirm this for us?

  8. @Frugal Dad @Caleb I actually just spoke with Vanguard today about opening up a Roth IRA because I am young and don’t have much knowledge but would like to get stared. I was actually told you can get started at $1,000 or $2000 but there is only one mutual fund option. When you hit the $3000 mark your options open up.

  9. If you have maxed out on your 401(k) and your IRA and decide to put more toward retirement in a taxable account then you should put the lower risk investments portion there. There would be fewer tax consequences that way since the high return/high turnover investments are sheltered in the 401(k) and IRA. For example, if you aim to keep 80% of your retirement in stocks and 20% in Govt. bonds. And you put $15,000 in your 401(k) and $5000 in your IRA and want to invest $5000 more then all of your 401(k) and IRA should be stock while the $5,000 you invest on your own should be in the Gov’t bonds.

  10. JD, the IRS keeps changing the Roth rules. I converted in 98 and had 4 years to pay the taxes due. It seems that the latest for last year is that one had 2008 ande 2009 to pay off taxes due, but there must be new rules this year. Gotta check with the irs website.

  11. T.Rowe Price has one of those set ups where you can pick almost any of their funds with no min as long as you do $50/month. I am positive of this because I set up one for my wife and my brother.