I have an employer sponsored 401k plan through Vanguard with an employer match. I am so ecstatic to have a job that gives me access to a 401k plan because I did not know that all jobs do not offer it as benefit.
With my 401k plan, it has allowed me to start preparing for retirement at an early age. Based on my research, it has been stated that it is best to start your 401k as early as possible because the longer the money is the stock market it can earn more money.
Now, I am at the point where I am trying to figure out how to maximize my 401k contributions so that I can ensure that I can retire by the age of 60 years old. Ideally, I will like to retire by 50 or 55 and only work because I choose to do so. My first step to doing that is first getting myself on track to retire by 60.
Things that I am Considering:
1. Contributing up to the employer match
Right now, I contribute 4% of my salary to my 401k (pre-tax). My employer plans to reinstate the employer match effective Jan.1, 2020 (matching up to 6%). They do it on tiered level.
They match 100% of the first 1%, 60% of the next 4%, and 10% of the next 1% of my salary.
I am planning to up my contribution by 2% to get the full match. I am not contributing more than that because my main financial goal is to pay off my student loans.
Retirement Calculator | How much do you need to retire? | NerdWallet
Based on the retirement calculator, I need to contribute 14% of my income and I am just not willing to do that right now.
2. Why I feel okay with increasing my 401k contribution instead of putting all the extra money to my student loans?
I feel okay with increasing my 401k contribution because my return on investment (ROI) or interest for my retirement account is higher than the interest that I pay out for my student loans. The current interest rate on my 401k as of now is 15.40%. The projected ROI over the course of the next 5 years is estimated to be 10.82%. This is substantially higher than the 5% interest that I pay on my student loans.
Essentially this means my money will go further in my retirement account than paying towards my student loans because that interest rate of my student loan is not that high.. This does not mean that I will stop paying off my student loans. I am going to pay them off as soon as possible. There will just be a slightly less amount sent to my student loans than anticipated based off my previous calculations.
3. Should I leave my retirement pre-tax, after-tax, Roth?
I am going to move from a traditional 401k to a Roth 401k because I plan to make substantially more money in the future. Because I will be making more money in the future if I leave my 401k pretax this would cause me to pay more in taxes in the future when I go to withdraw the money. By paying the taxes now, I can withdraw my contributions and earnings tax-free.
Traditional (Pre-tax) 401k
A percentage of your income is transferred to your 401k prior to tax being assessed on your income. This is a good option to reduce your taxable income.
After-tax 401k
Your income is taxed prior to the percentage of your income being moved to your 401k. With this type of account when you withdraw the payment your earnings will be taxed at the time of withdrawal.
Roth 401k
Your income is taxed prior to the percentage of your income being moved to your 401k. At the time of withdrawal, you can withdraw your money tax-free. With a Roth 401k, your contributions will need to remain in the account for 5+ years since first contribution to the retirement account.
Resources:
Traditional 401k vs. Roth 401k: Roth 401(k) Vs Traditional 401(k): Investing Pre-Tax Or After-Tax (forbes.com)
Retirement Calculator: Retirement Calculator | How much do you need to retire? | NerdWallet