401(k) vs. IRA - Which is Better For Your Extra Money?
Once you're contributing up to your company's 401(k) match, do you continue upping the % or do you jump to the IRA?This is one of the questions I get asked the most as a PF blogger (the other is probably how to start blogging or the order to pay off credit cards), and it usually comes down to personal preference. Since I mostly respond back the same way all the time, I figured I'd copy & paste the question and my answer below and see if maybe YOU have some better advice on it this time around? That way I could refer them back to this post in the future :) Here's the question from Mr. Wants-to-take-advantage-of-retirement-plans:
"I'm like you, turned 30 this last year, and getting my finances in line (I'm in the black, which is a good thing, but I can do better)....got a question for you regarding 401k's and IRA's. I currently participate in my companies 401k program, but I am only contributing the amount that the company matches (i.e. 60% on my first 6%...). However, my 6% doesn't even get me close to my annual maximum ($16,500 or so... whatever it is...(J: Yup, that's correct!)).First of all, GOOD WORK on matching up to that 6% already - 90% of people never even consider it. Second, I like that you're asking this as a lot of people wonder the same thing (me too, at times) and to be honest it's a tough call. You're right in that I'm not a professional, so I can only tell you what I would do in your shoes :) And that would be to compare the funds available in your 401(k) vs. the IRA, or even better, Roth. The Roth is the bad boy these days and much more pimped out than the Traditional - but still do your research to make sure it works for ya.
Would you suggest hitting the $16,500 in my 401k before setting up a separate IRA account? Or would you just contribute to the 401k up to the employer match amount, and then max out an IRA each year?"
But back to the funds. *Most* 401ks from smaller companies usually suck as the funds to choose from aren't as good as if you had the open-sea of EVERYTHING out there like you do with IRAs. My company has a great match at that 100%, but the funds are pretty shitty from what people tell me. So, if I were only getting the 6% match then I'd do that, or maybe even up it to 10% to keep it even (I always round up) and then work on maxing out my Roth. This way, you could pick much better places to put that money and in all types of products - mutual funds, stocks, bonds, whatever you want really. It might depend on which institution you go to open one up, but it's nothing Google can't help you with. I'd start at Fidelity or Schwab and go from there. (Or, USAA if you qualify - that's who I use for my Roth) .
Not only should your money get into better places this route, but you hit that max a lot quicker giving you that feeling of Awesomeness. The Roth & Traditional IRA max out at 5k this year, so you could break up the payments from now until the end of the tax year to make sure & evenly distribute the money until maxed. In all honesty, you've already gotten 80% of the smart investing part down as either route you take is bad ass :) But that's what I'd do - keep your 401(k) contributions to 6-10%, and throw the extras into an IRA. What would you guys advise?
Labels: 401k, advice, reader mail, retirement, roth ira
posted by J. Money at
7:37 AM
30 Comments:
Definitely agree with the flexibility of a Roth. In addition to Schwab, Fidelity, and USAA, I'd also recommend TD-Ameritrade. You could also open one directly through Vanguard if, like me, you're madly in love with their funds. ;)
Also, since you take the tax hit now with a Roth, future tax changes (surely higher than now) are irrelevant to money in said Roth. I think that's extremely attractive.
An additional point in favor of maxing out an IRA before going back to the 401(k) and maxing it out: In addition to high-cost funds, most 401(k) plans charge administrative fees (usually in the ballpark of three quarters of a percent).
Costs add up.
Def going with a Roth all the way. With the current state of the economy and the continuing uncertainty that lies ahead for our financial markets, I would much rather pay taxes now on the money and be able to use that money tax free 25-30 years down the road. Imagine looking in your account and knowing that every penny of that principle is yours. With currency values dropping every year, inflation increasing, I see the value of $1 million dollars today not being the same 20 years down the road.
@Blake I am in love with the Vanguard funds too! Primariliy b/c thats all they offer me in the company plan.
J. Money,
Like most great PF advice, there is no one set answer. I tend to agree with a low cost IRA (traditional or roth begs more questions), but there are benefits to 401(k)s vs. IRA that most bloggers don't really go into:
http://www.myjourneytomillions.com/articles/sometimes-401ks-are-better-than-iras/
Gnerally, I like your advice, but there are some caveats, but analysis shouldn't cause paralysis
For sure - researching all your options is def. the way to go before jumping in. That's why I'm glad you guys are here :) It's great to hear from a mixture of others as it usually does come down to personal preference.
I agree he will have more options in the Roth and should max that out if he can.
Right now is the PERFECT time to be putting $$$$$$$ into your Roth! Taxes right now are the cheapest they have ever been in a LOOOOOOOOOOONNNGG time. Why not pay the taxes right now, while it is low and let it grow tax free :) With a 401K, your only delaying the inevitable which, if we keep up this spending foolishness, will place us in a higher tax bracket and therefore lose more of our nest egg when we try and use it (Not to mention we'll be making more towards the later years of our lives - again, increased tax bracket [esp the first year widthdrawing]). I am not a professional, not do I claim to be, but common sense says stockpile away now while taxes are cheap because our tax system is bound to change (cant keep borrowing at this rate - but that's another story for another time).
My advice, match employers contribution and then max out the Roth IRA, then if you have any left over, take your husband/wife out knowing you're doing your do diligence for your future :) Or just it away into the 'rainy day' fund <-- Good option with this economy!
@Blake and @Doctor S: I also love Vanguard funds and their low fees.
I like the above comment:
"My advice, match employers contribution and then max out the Roth IRA, then if you have any left over, take your husband/wife out knowing you're doing your do diligence for your future :) Or just it away into the 'rainy day' fund <-- Good option with this economy!"
I think I would do something very similar. I would follow Suze Orman's advice - max out employer match, then max out Roth IRA, then throw some more money into the 401K.
I also am leaning towards contributing to the employer's match, and switching any remaining over to a Roth IRA... definitely can't pass up the free money, regardless of the current taxes, value of the dollar, etc.
Seems like the Roth will give me more options than I can count on my fingers and toes... unfortunately, that's only 18 total right now, since I contributed one big toe and a pinky to a research study... but hey, I did make a couple hundred for participating (SCORE!)...
401k's - good funds/options, fees or not - compel you to save because once it's gone, it's tough to get back. With an IRA, if you are able to fund it automatically every month, good for you, but it can be tempting when you see those paychecks rising.
Of course, always hit the 401k to the match (assuming it's vested) then I'd gun a good 401k to the max.
Yes, a Roth or IRA gives you more options, but it also puts the money into your checking account first (unless you direct deposit to your IRA) and then can be tempting to take.
I came in here to mention my love for Vanguard, so I'm going to mention my love for Vanguard, no matter how many brilliant folks before me have done so.
Vanguard is like the Costco of funds. Low overhead = Low cost = I buy in bulk.
Another vote for Vanguard!
I think the advice is definitely sound. Since he's only 30, after the match I'd switch to the ROTH for tax advantages later down the road and if he maxes that out too go back to the 401(k).
JB
I'm not sure what I would do as I don't have either of these accounts yet. There is so much pressure about retirement these days with very little info on what these actually are and how to use them so to see such good info is great. Thanks, keep it up
@Jesse, Go out and read about it, get started. No one will take care of your future. It is YOUR job to do so. People go to college not only to learn, but to be taught how to do research. Long after school your still learning! Go pick up a book, do a web search, but in the meantime starting putting something away for your future.
A few people have already mentioned what many professional advisors recommend: Invest to get the company match, then max out your Roth IRA, then if you have additional funds to invest, consider adding those funds to the 401k. But if you have other needs, you can do that as well. There really is no one-size-fits-all answer.
@AG - Backing Up The Truck - glad to see you're a risk taker ;)
@ almost everyone's comment, good advice by J, use the match and then do the Roth max. This is exactly what we are doing right now with ours. And we Rothed with Vanguard based on lower fees and returns being pretty equal best I could tell.
I will also include a hedge we are doing, I'm not convinced the market doesn't have another big dip in it. As such we have half maxed the Roths and are prepared to do the other 1/2 before the April 15 deadline but haven't committed the $$$ to the fund yet (its just sitting in ING right now). Current returns over the past 3 months make it look like a bad call b/c the market is moving right now BUT I'm just not comfortable with the fundamentals of this "recovery".
Add me to the list of Vanguard fans! I would not trust my Roth to anyone else! (Fees are MUCH lower than Fidelity's, where my husband and I have his 401k.)
My order is:
401k up to match
IRA
401k up to limit (or as much more as I can)
410k up to match 1st and foremost b/c the match is basically free money. IRA 2nd b/c the variety of investments cannot be beat (beyond stocks & funds, etc.). Then back to 401k.
My vote is to max out to the employer match limit, then max out your ROTH IRA, and then throw whatever else you have back at your 401(k).
The biggest reason, as others have stated, is to take advantage of your tax situation. Most people will make more as they progress, and eventually cap out of where the ROTH limits are, if they are lucky. Put your money away now while you are making less and you'll be better off.
The other big thing I would do is keep stretching yourself and adding on a bit at a time. Back when I first started contributing I thought it was virtually impossible to max out. After we got married I upped my contribution by quite a bit, and then realized I could still get by, so I upped it again. I kept doing this until I maxed out. I was surprised how quickly this happened. It was a great strategy for me and now I max out on auto pilot.
Now however, I'm also lucky in that my employer just switched to allow a ROTH 401(k). I'll be blogging about this next week!
Keep up the good work!
Miel @DINKs_Finance
The IRA is a total farce! After you making over $105,000 you can't contribute a dime. The government should raise the income limit for contribution to $250,000 at least. What does a 29 year old MBA graduate who makes $150,000 supposed to do? 401K contribution should be raised to at least $30,000. After 30 yrs of saving 16.5K/yr, it's just not enough.
Interesting...are YOU that 29 y/o MBA by chance? ;) I don't know much about what the gov't should or shouldn't do (probably best for another blogger to tackle) but I do see your point here. At least you can still invest all your extra money though, it's not like it just gets wiped out. Or maybe you can find a better job that ups the ante on matching % part of it all?
@Miel @DINKs_Finance - awesome! it really is hard to imagine at times, but once you learn to live off less it keeps getting easier and easier :) That's wonderful too that you're getting a ROTH 401K!!! Looking forward to your post on it.
I have provided my answer to the question in the post YOU ASKED FOR IT at http://wanderingtaxpro.blogspot.com/2009/09/you-asked-for-it.html.
TWTP
Talk about a complete & thorough answer! Loved how you broke it down between "tax considerations" and "non-tax considerations". Well done my new friend :)
You did a great job explaining it. A ROTH truly rocks. With the ROTH you get the added benefit of being able to withdraw your contributed funds without penalty. You get bit pretty hard by the 401k and traditional IRA if you have to withdraw money. Taxes and a 10% penalty.
Balancing your 401k, ROTH and Traditional IRA is the best approach. We teach diversification in the stocks we pick but rarely talk about it from our investment vehicles.
Plus the ROTH lets you benefit if taxes go up (which they probably will) while the 401k and Traditional give you the added bonus of upfront tax savings. Using them all makes the most sense. 401k with match first, ROTH second to MAX. I would probably suggest leaving the Traditional out and focusing on just the two to really knock it out of the park
Go to the ROTH. If you think your employer offers great funds you can buy the retail equivalent in your ROTH. Otherwise you're ready to take advantage of the wealth of possibilities.
Another point in favor of the ROTH (both the ROTH IRA and ROTH 401k) is, as I understand it, there is no minimum required distribution.
So if you don't actually need some of those funds in retirement, you can leave them to your heirs - see a tax pro about this, which I am not.
Especially for someone who may be eligible for a traditional pension (like the military and some older workers), the required distributions and the resulting tax burden are a point against the traditional IRAs and 401Ks. But certainly hit the match point - don't leave free money on the table!
Interesting, hadn't even thought about that really...def. a good thing to bring up to a tax professional and check out :)
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