Welcome to the 3rd week of my ‘Understanding Retirement Planning & Investing’ series! If you’ve missed the first two posts be sure to check them out!
With the understanding that a 401(k), 403(b), 457, Roth IRA, and Traditional IRA are simply investment vehicles – tax-sheltered accounts (an umbrella) that allow your money to grow tax-deferred – the next step in the retirement planning process is to learn which account(s) will be the best places to save your retirement contributions.
This may seem basic to some people but I get asked all of the time, “where is the best place to invest money for retirement?”
Should you put money in the 401(k) before you contribute to the Roth IRA?
Why not contribute to the Roth IRA before the 401(k)? You know about all of the great benefits that I talked about in my first post of this series, so it might seem logical to start with the Roth.
As a financial advisor, I personally follow this route and recommend it to all of my clients.
Free Money?? Who would say no to free money?
Well, people do it every day! It’s right under their nose and they just walk right past it without understanding they’re passing up FREE BENJAMINS! .
All you have to do is go win the lottery or get an inheritance. BOOM! Free Money! You can thank me later. 🙂
In all seriousness, what I’m talking about here is taking advantage of the company match provided by your employer!
While some employers have suspended their matching (post 2008) many continue to do it in some fashion. If you have a 401(k), 403(b), or 457 and your employer is offering a match, that is the first place you should invest your retirement money!
Don’t take my word for it. Let’s think about this logically…
If your employer is matching 100% or 50% of your contributions then that is FREE MONEY! That is a 100% or 50% return on investment, respectively, BEFORE YOUR MONEY EVER REACHES THE MARKET!
You simply can’t beat a 50%, 75% or 100% return on your investment.
After you’ve contributed to your employer sponsored plan up to the company match, if you still have additional money to contribute to retirement savings, then the next thing I look for is Tax-Free accounts.
While there are a few different Tax-Free retirement vehicles and investments, the place I’d suggest to consider first is the Roth IRA.
To jog your memory there are a few special benefits of the Roth IRA:
In my mind there is ZERO doubt that taxes will go up in this country – ESPECIALLY FOR HIGH INCOME EARNERS.
What…you think you’re not a high income earner? If you start saving for retirement early, invest prudently, and build a LARGE nest egg, do you think it’s likely you’ll be in a higher income tax bracket in retirement than you are today? I certainly do!
On top of that, the reality is that there are only a few ways our country will ever get back on sound financial setting and part of the solution will have to involve increasing taxes, for everyone! Period.
I’d rather know my tax liability today and take the hit now, instead of relying on our government to manage our country well over the next 30-40 years and HOPE that taxes will be the same as they are today (or lower) by the time I retire.
After you’ve taken full advantage of your employer’s contributions AND once you’ve maxed out your Roth IRA contributions, then I’d invest any further retirement savings into a tax-deferred account (if you’re confused by those definitions then please see the 2nd post of the series that I mentioned at the start of this post).
This means to go back to the 401(k), 403(b), or 457 and contribute as much as you can up to the maximum amount allowable (50% of your income or $17,000/year as of 2012 – whichever is lower).
This may be clear by the suggestions above but my belief is:
For those of you that want an easy breakdown and prefer for somebody to tell you what to do without understanding the reasoning, then here.
1. 401(k) – UP TO THE MATCH
2. Roth IRA – up to the limit ($5,000/year or $6k/year if over 50)
3. 401(k) – up to the limit
If you don’t have a 401(k) then contribute to whatever employer sponsored plan that is available to you (403(b), 457, etc.).
I realize many people believe throwing money in their 401(k) is easier than contributing to a Roth because they never actually get to see the money. However, that lack of discipline forces those people to skip step 2 and miss out on future TAX-FREE money.
At the end of the day, which order you choose comes down to whether or not you believe taxes will go up over time. I know I do! PLEASE give me all of the future tax-free money that I can get!
THANK YOU MAY I HAVE ANOTHER!
The articles are written by personal finance enthusiasts (not certified professionals) based on their personal experience. What works for them may or may not work for you, and you should always consult a financial advisor before making important financial decisions.
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