Where to Start on Retirement Savings
If you're fortunate enough to have more than one type of retirement plan available, in what order should you contribute to them?
Most folks have some sort of tax-deferred retirement account available, such as a 401(k), 403(b), 457 or deferred compensation. (For the purpose of clarity, when I refer to a 401(k) plan, I am referring to all of these kinds of plans.)
If your employer matches your contributions, you should choose the 401(k) as the place to start. Your employer may match your contributions to the 401(k) at a rate of 50 cents per dollar for the first 6% you contribute, for example. This means that, if you make $50,000 per year and you contribute 6% ($3,000) to your 401(k) plan, after the employer match you'll have a total of $4,500 contributed to your account. With the 50 cent-per-dollar match, you're making a 50% return on your money before you invest!
A bonus is that the contributions you make are pretax, so they cost you less. The $4,500 contribution to your account reduces your take-home pay by only $2,250 if you're in the 25% bracket, for example.Next, contribute the maximum amount to your Roth IRA. Some of the benefits of a Roth IRA include the following:
- Once you've contributed funds to the account, qualified withdrawals from the account will be tax free. Your tax-free withdrawals can begin when you reach age 59½.
- You can withdraw the contributed amount (but not the growth) any time you wish, for any purpose.
- The entire account may be withdrawn for other qualified purposes, such as a first-time home purchase, before retirement.
- Traditional IRA: If you don't have access to an employer-sponsored income deferral plan such as a 401(k), you may want to reduce your tax burden a bit by contributing to a traditional IRA. The limits on contributions are the same as for Roth IRAs, but you can only contribute the maximum amount in either a Roth IRA, a traditional IRA or a combination of the two.
- Taxable account: As you max out your tax-deferred options, a taxable investment account will give you tax diversification. By adding a taxable account, you'll have Roth (nontaxed), tax-deferred (401(k) or IRA) and currently taxed (capital gains) funds available for use.
- College savings plans: After you've funded your retirement, consider placing some money in a 529 plan or Coverdell Education Savings Account for your child's education.
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