Retirement savers have several types of investment accounts to choose from. Many investors have the option to open a 401(k) account at work but could also open an individual retirement account. Here’s how to decide which account to fund first and whether you should put money in an IRA before you completely max out your 401(k) plan.
[Read: How Your 401(k) Balance Stacks Up.]
Know the limits. A 401(k) and an IRA have different contribution limits. In 2016, you can invest up to $18,000 in a 401(k) plan, not including any employer contributions. If you’re age 50 or older, you can add an additional $6,000 to your 401(k). For an IRA, you can invest $5,500 in 2016, plus an additional $1,000 if you’re age 50 or older. However, your IRA contribution amount may be reduced or eliminated if you have a 401(k) at work and you have a modified adjusted gross income over $61,000 ($98,000 for couples). Eligibility to make Roth IRA contributions begins to be phased out and eventually eliminated after your income reaches $117,000 ($184,000 for couples). As with contribution limits, these income-based limits can change from year to year.
Get a 401(k) match. If you’re eligible for an employer contribution to your 401(k), your first priority should be to invest at least enough money to get that match each year. Otherwise, you’re missing out on free cash. IRAs don’t offer a match on your contributions. However, when it comes to employee matches, be sure that you’re going to get to take the employer contribution with you when you leave the company. You might have to work for your employer for a certain number of years before you’re fully vested in the 401(k) plan. While you will always get to keep the money you personally contribute to your 401(k) plan after you leave the company, you don’t get to take employer contributions with you until you are vested in the 401(k) plan. In some cases, you might be partially vested and only be able to keep part of the employer-invested amount until you spend a specific number of years on the job.
[See: 10 Ways to Make Your 401(k) Balance Grow Faster.]
Watch out for fees. Do a close examination of your 401(k) to check out its fees and investment options. While some employers offer low-fee accounts with flexible investment options, this isn’t always the case. If your 401(k) has bad investment options or high fees, you may want to move money into an IRA sooner rather than later. Even if your employer provides a good 401(k) option, you will probably have a limited number of investment options and won’t have as much control over your investments as you would with an IRA. When it comes to an IRA, you will be able to choose your own account provider, so you can shop around for low fees and good investment options. Just be sure that you do shop around so that you can open the lowest-cost IRA you can find.
Consider future flexibility. When you’re investing for retirement, it’s best to avoid taking money out of those accounts until you actually retire. But sometimes, life happens. Maybe you get a huge medical bill or need to use retirement investments for a down payment on a home. In these specific cases, you might be able to take a penalty-free withdrawal from an IRA to help cover the bill, but a 401(k) withdrawal would have a 10 percent early withdrawal penalty. And in the case of a Roth IRA, you may also be able to avoid paying income tax on an early withdrawal. However, if you eventually have to file for bankruptcy, 401(k) plans provide better protections from creditors.
Decide whether Roth or traditional is a better option. Roth IRA contributions go into the account after tax, but they often aren’t taxed when you withdraw the money in retirement. Some employers also provide a Roth 401(k) plan, which allows you to pay the tax on your retirement savings at your current tax rate and avoid taxes in retirement.
[See: How to Reduce Your Tax Bill by Saving for Retirement.]
While you should always put enough into your 401(k) to earn any available employer match, after that where to save becomes a trickier decision. If your employer has a high-fee 401(k) plan, you may want to then fully fund your IRA instead of adding more to the 401(k) plan. However, if your employer has filled the 401(k) plan with low-cost funds, you might want to stick with that until you max it out, and then put any leftover cash into an IRA. You can also save in both a traditional and Roth account to hedge your bets about future tax rates. Both of these options can work well for you if you know what you’re getting into, save as much as you can and look for the lowest cost and highest return on your investments.
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Should You Open an IRA Before You Max Out Your 401(k)? originally appeared on usnews.com
