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Im 25yrs old i had traditional 401K then switched to roth and now back to traditional. Investing 7%. Which is better?

My company matches 50% up to my 4%contribution. Today i just bumpednit up to 7% but i switched to a Roth and then back to traditional. Im not sure on which one to pick. Theyre both beneficial, i hear the Roth is great but paying after tax dollars for the next 40years sounds painful. Also i switched my investment from the t rowe price target date fund 2050 to a spartan fidelity index fund standard & poor's 500. Was this a good move? Also should i go back to roth or stay traditional? Thanks!

Sep 16, 2014 by pedro from Yonkers, NY in  |  Flag
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Layton Jacob Cox Level 11

Hi Pedro,

Congrats!

I like David's answers but I have some peer-to-peer insight advice he may not have.

  1. Roth it all the way. Ask any CPA if they think that tax rate will go up or down in 40 years. They'll say up. Paying taxes now is the thing to do.

  2. In the long run (20+ years), the S&P 500 fund will make you more money. You have a long amount of time ahead before you can/should touch the money. I'm in the same boat as you. I've got a long time for my 401k funds to grow. I actually put my money into higher risk funds because I know I don't need the money for a long time.

Risk tolerance and all that jazz is something our industry made up to make is sound like we do extra work.

Behavior management is what you should be focusing on. Learning that when the market goes down, that is the best time to buy and worst time to sell. Learning when the market goes up, is the best time to sell and worst time to buy. Learning that there has never been a 20 year period of negative growth in the US Stock market. Teaching yourself these facts now will help you create a successful retirement.

Good luck buddy and don't sell,

1 Comment   |  Flag   |  Sep 17, 2014 from Tucson, AZ
Dustin

Hey Pedro,

Based on the information you've provided and without knowing anything about your risk tolerance, I would recommend not moving all of your assets into the S&P500 index fund. The 2050 retirement date fund offers you a greater level of diversification across the global economy, it holds 90% in stocks or equities and 10% in bonds. Regarding the Roth scenario, if you think you will be earning more in retirement, you should select the Roth option, if you you think you will be earning less, then the standard 401(k) will be the route to go. If your plan allows for it, you may be able to go with a hybrid approach and use both.

I hope this is helpful to you.

Flag |  Sep 17, 2014 near West Fargo, ND

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Hi Pedro,

The most important thing is that you ARE saving money and contributing towards your retirement. Over the long run, the compounding you get will allow you to save a significant nest egg, which will improve your financial flexibility over your lifetime.

So to your first question: Is it better for you to invest in a traditional 401k or a Roth 401k? As you probably know, a traditional 401k is tax-deferred savings where you don't pay taxes on contributions or earnings until you take distributions, which you MUST take by age 70 1/2. For the Roth 401k, you are paying current taxes on your contributions, but earnings will be withdrawn tax-free. The answer to your question depends on how much money you are making, what your tax bracket is, and what your tax bracket might be in the future. Since you are 25, lets assume that your tax bracket is lower right now: maybe 10 or 15%. In this case, I think the Roth makes the most sense. Pay your taxes now at a low marginal tax rate and take the money out in the future tax-free. But if you are in a high tax bracket now, especially if lowering your taxes will benefit you by giving you access to deductions or credits which you would not get otherwise, then you will want to lower your current taxes and use the traditional 401k.

Your second question is should you invest in the target-date fund 2050 or an S&P 500 index fund. I can't make a specific recommendation without knowing more about you including your risk tolerance. I will say that the target-date 2050 fund is going to have a lot of stock market investment in it and probably has an S&P 500 index fund in it, or certainly a fund which tracks the performance of the S&P 500. But as you get older, the target-date fund is going to change its investment mix to have fewer stocks and more fixed income. But everyone's situation is different and this may or may not be appropriate for you. When I advise clients about their 401k investments, I usually choose a mix appropriate to their specific situation and review it periodically. But without a financial advisor who does this for you, the target date fund may be the best alternative.

Comment   |  Flag   |  Sep 16, 2014

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Hey Tunc... due to your age, my knee-jerk reaction is to recommend the Roth 401k. There are no income testing limits, so even if you "make too much" for a Roth IRA contribution, you can still contribute to the Roth-401k. With that said, I'd highly recommend talking to your CPA about this decision as they would have a big-picture assessment of your financial situation. If you don't have a CPA, I'd look for one in your area via AngiesList.com or the Society of CPA's in Mass. From there, I'm sure you can find a CPA that will give you their time, even if it's just to ensure you're getting this right. With that all said, a "hybrid" approach might make a lot of sense...again, all depending on your personal financial situation.

Regarding the investment choice (S&P Index Fund vs. Target Date 2050), I'd agree with Dustin in that the Target Date fund will offer you more diversification, but you're asking us to give you advice between only two options. Surely your 401k has more to choose from, and I'm sure other advisors would agree with me when I say you should check on those other options and perhaps build something a little more substantial (from an asset allocation standpoint) than simply using one investment option or another (or even "just two" options).

With that all said, I'm not a Target Date fund fan... I think there are conflicts of interest that arise with these funds wherein investment companies will spread out your money amongst both the good AND bad funds they manage. Further, as you get older, they will automatically allocate your money to a plain-Jane cookie-cutter Equity/Fixed Income allocation that you might not want to own. The portfolio management world has a lot of catching up to do in light of today's government debt and interest rate environment.

1 Comment   |  Flag   |  Sep 23, 2014 from Dublin, OH
Tunc Tanin

Rot Ira is almost always preferable to a Roth 401k.
You have access to principal anytime, you dont have to wait until age 59.5. Roth 401k is not available unless we are talking about a loan. A roth 401k is also subject to RMD's unless you roll it over to a Roth IRA before age 70.5

Flag |  Oct 01, 2014 near Somerville, MA

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Pedro I agree with a lot of the information already mentioned, but specifically here are my thoughts 1 - The fact you are savings early and often is most important. Keep this up, and try to increase your savings as you can afford it. 2 -Who knows where tax rates are going. Prognosticating that is like prognosticating the market. Good luck! 3 - You seem to have a handle on ROTH vs. Traditional. My knee jerk reaction is to say a ROTH (that is what I did in my 20's). The good thing is by contributing to a ROTH is you will actually end up with both. The money your company matches will go into a pre-tax account. 4 - As for the S/P 500 vs. the target date, I could argue this both ways. Either was is good as long as you can handle the inherit ups and downs you will likely experience.

Hope this helps

Comment   |  Flag   |  Sep 23, 2014 from Exton, PA

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Glenn J Downing Level 5

Roth, my friend. For all of the reasons cited above. You'll gain significant income tax savings with a home purchase, so keep that on your planning horizon. Just think - someday you'll have access to an account with will north of $1.0 million with NO TAXATION! That's huge! A little pain now for big gain in the future.

Comment   |  Flag   |  Feb 04, 2015 from Miami, FL

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Tunc Tanin Level 10

We don't know what income tax bracket you will be in 40 years, we may even have a different tax system then. We may have 3% income tax rate and 55% sales tax rate. Who knows. However, if you happen to loose your job and you did not have enough other savings, Roth is more advantageous then a regular IRA as you can withdraw the principal tax free. I hope you never have to do that, but then who knows what the 40 years will bring.

Comment   |  Flag   |  Sep 22, 2014 from Somerville, MA

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Steve Casull Level 13

It only matters what income tax bracket you're in now. Assuming it is low, contribute to the Roth. ANd if I may be so bold to say, cut off the 401K contributions to only the 4% that your employer matches. Put the remaining 3% into the ROTH. Now, I am assuming a lot in this. FOr all I know you just invented some APP and make $1MILLION a week, which if that's the case, disregard all previous advice from everyone, google my name, and meet your new best friend!

Comment   |  Flag   |  Feb 11, 2015 from South Jordan, UT

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