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401k vs. IRA: Where should you save?

With so many options available, what's the best way to set aside money for retirement? Here's a suggestion.

By MSN Money Partner Apr 19, 2012 9:52AM

This post comes from Rob Berger at partner blog The Dough Roller.


The Dough Roller on MSN MoneyAmong the many decisions we all must make about retirement, one of the most perplexing relates to the types of retirement account options.


Image: 401k (© Photodisc/SuperStock)For many of us, there are a lot of choices, including a 401k, Roth 401k, deductible IRA, Roth IRA, and a nondeductible IRA. And that's not even counting 403b accounts, SEP IRAs, self-directed IRAs and, of course, taxable accounts.


And if that weren't enough, for many of us the best options are a combination of 401k, IRA and taxable accounts.


Recently I came across a post on the Bogleheads forum (an excellent investing forum) that addressed this question. According to the good folks at Bogleheads -- named after the founder of Vanguard, Jack Bogle -- retirement investing should be placed in the following types of accounts in the order listed:

  1. 401k/403b up to the company match.
  2. Max out Roth IRA.
  3. Max out 401k/403b.
  4. Taxable investing.

While your situation may be unique, I think the above priority ranking is, as a general rule, quite sound. Here's the rationale behind this list:


A 401k or 403b up to company match. When your employer matches some of your contribution, it's critical to take full advantage of the match. Otherwise, you're just turning away free money. The value of the match makes this the first place to stash your retirement savings. (Post continues below.)

Roth IRA. Once you're saving enough in a 401k to get the company match, additional retirement savings should go to a Roth IRA, according to the Bogleheads. While I think arguments to the contrary could be made here, I like this approach for two reasons.


First, many people assume that taxes will go up in the future. So, unless you are in the top tax brackets today, many recommend paying taxes on the income now and enjoying tax-free growth and retirement distributions later with a Roth IRA. And with retirement savings in both a 401k and Roth IRA, you have some investments that are tax-deferred and some that grow tax-free, which is a nice way to hedge your bets when it comes to future taxes.


Second, with any IRA, you can choose where to open the account. Many 401k plans charge extremely high fees and have limited investment options. For those who like to keep investing simple, Betterment is an excellent option for an IRA (read my review here). If you like to trade, I think Scottrade is a great choice because of low fees and physical branches just about everywhere. However, many brokers offer IRA accounts.


Keep in mind that your income may disqualify you from opening a Roth IRA. You can check out the 2012 Roth IRA limits here.


Max out 401k/403b. Once you've maxed out your Roth IRA, top off your 401k. Keep in mind the limits on contributions, which can change from year to year. For 2012, the contribution limit has been increased from $16,500 to $17,000. The catch-up contribution limit for those age 50 and over remains unchanged at $5,500.

Taxable accounts. Unless you qualify for a SEP IRA, the next and last stop is a taxable account. Here you can open an account with a mutual fund family like Vanguard or Fidelity, open a brokerage account, or use a service like Betterment.


As I mentioned above, every situation is different. The above priority list may not be ideal for everybody. But I think it's a sound way to approach retirement investing.


More on The Dough Roller and MSN Money:

Apr 20, 2012 9:08AM
Lots of people are retired on less than 40k a year. Lots of family's live on that or less also.
Apr 19, 2012 5:40PM
A year ago with my wife's 401k account we started making her contribution only that which would equal her company's matching amount. We took additional money each pay period and placed it into a Roth IRA. We did this for several reasons. First, of the more than 14,000 mutual funds available, her company provided her 32 to choose from. Second, the tax saving now will pale in comparison with the possible taxes she will pay later in her life. Third, she controls the withdraw on the account, not the mandatory RMD at 70 1/2. Like no one is going to need the money from their 401k before that time anyway. America's new pensionless retirement is going to require withdrawing money before 70 1/2 anyway. Ever wonder why ING's "What's your number?" ad campaign features a low figure in the $800,000s for retirement. Because, as Wall Street says, "withdrawal 4% per year." So, 4 percent of $800,000 is $32,000. Less taxes it will be approximately $26,000 plus Social Security. First, who is going to be able to live on approximately $40,000 a year in retirement. And second, who is going to have $800,000+ in their 401k? As was stated during the congressional hearings in the 1970s about the implementation of the 401k, "It will be the ruination of retirement in America." We just never listen and learn the hard way.
Apr 20, 2012 9:18AM

Careful - while 70½ is the RMD age, you may start withdrawing penalty free at 59½.  Depending on your tax bracket, I would encourage you to do so up to the top of your current tax bracket whether you need the money or not.  That will give you more flexibility at 70½ by reducing the amount of your RMD.  If you don't need the money, you can stash it into a taxable account - prefereably a tax efficient fund such as a low cost index fund that will not "churn" the investment. 


$800,000 is not a lot to have in your retirement accounts if you start saving diligently by the time you are 30 and don't do silly things like "trade" your retirement accounts.  About $525 per month increased by 3% each year (reasonable wage increase even without any promotions).  This is not a small amount for many people, but  workable for many if you are committed and this is your first priority.  Especially true if you get any kind of employer match.

Apr 20, 2012 3:40PM
When working, before the economic meltdown, I was able to max-out both my 401K & Roth IRA. Recommend doing so, if possible to everyone working, just like they suggest too. When I became unemployed after turning 50 it has helped me out tremendously. Now with only 20 months to go, until I can retire out with a early pension clause at 55, I'm glad I made those sacrifices to put those monies away. Now if I could only get my children to do the same, like talking to a brick wall, again thats another story. Put your monies away when you can, it will help out in the end when things wind down for all you working people. I CAN'T STRESS THAT ENOUGH!
Apr 25, 2012 11:45PM
Why is the IRS willing to let people defer up to $22,500/yr (more for business owners) into a 401k plan?  The more you defer now, the more the IRS is going to get in the end.  So, in the interest of reducing the national debt, I am maxing out my 401k.
Apr 21, 2012 12:43PM
Why Roth IRA instead of traditional IRA?  I used to have around 5 or 6 401(k) accounts from previous employers (2000-2010 was a lost decade for me with lots of gaps in unemployment), so I consolidated them into one traditional IRA (with the exception of my current employer).  I agree that I get far more choices with funds in my IRA compared to a 401(k)/403(b) plan, and I have expanded my portfolio even more with my IRA.
Apr 20, 2012 1:58PM
I do like the Roth approach of having way more investment options than most 401k's have. But maxing out the 401k also goes a long way to minimizing current AGI, which means more tax savings. If you have the luxury of maxing both accounts, then those savings can go directly into taxable investment accounts. Cha-ching!
Apr 20, 2012 9:12AM
Quit trying to save, take what money you have left 7 GET OUT! The corrupt corporates SNEAKILY STOLE your PENSIONS and gave you 401k which is nothing more than an insurance policy for them! If they fail, we, the 99% American People fail ! Now it is backfiring on them! They NEED MORE of the 99% American People's money to keep from TOTAL COLLAPSE!

Vote STRAIGHT DEMOCRATIC, the life you save may be your OWN!!!
This message is being brought to you by a LIFELONG DEVOUT REPUBLICAN who is totally disgusted with corrupt corporate government rule! I have nothing personal to gain; only satisfaction that I have helped my 99% Fellow Americans!

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