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401(k) With Company Match or Roth IRA?


Rivka asks: I’m 25 and switching jobs. My old company didn’t match 401(k) contributions, so I put 6% of my salary into a Roth IRA. My new company, however, matches 100% on the first 3% of my salary that I contribute to their 401(k) and 50% of the next 2%. Should I contribute 5% to my 401(k) and then a little more to the Roth IRA? Or should I just let me IRA sit for the time being and not contribute? What about a savings account? (I currently contribute $300 a month to a high yield savings account.)

Congrats on the new job and the great saving habits thus far! It sounds to me like you already have a solid saving plan figured out.

I would recommend doing exactly what you suggest—contribute 5% of your salary to your company’s 401(k) plan to take full advantage of their matching funds. Next, take any additional funds and put them into a Roth IRA (up to the $5,000/year maximum in 2009).

As for how much you sock away into a savings account, it depends on your existing savings and your goals for that money. The first step is to have a few months’ expenses saved in an emergency fund. If you’re still working on that, I would contribute as much as you can afford to the savings account until you have that cushion of between three and six months’ expenses.

Next, it’s onto long-term goals: 20% for a down payment on a home or the ability to pay cash for your next car or vacation, for example. Once you’re saving a solid amount for retirement every year, are out of debt, and have an emergency fund, it’s up to you how to spend or save your money. That is true financial independence!

Thanks for the great question, and best of luck! Do you have a money question you could use some help with? Send it to me and I’ll do my best to answer it in a week or two here!

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About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

Comments

  1. So here’s a follow-up question; let’s say that I’m contributing 10% to my 401k. My company match runs out at 5% so half of what I put in doesn’t generate a match at all. Are you saying this is a bad use of my money, and that I should allocate it someplace else (such as my Roth IRA) first, before I start dumping extra into my 401k?

  2. Jason: I believe it may be better to put the 2nd 5% into the Roth IRA if you are younger, as you will most likely be taxed at a higher rate when you withdraw the funds from the 401k later in life.

    Not sure, that is the general idea, though.

  3. Makes sense. But is there benefit in lowering my tax basis right now? I live in the Bay Area so my income is fairly high by national standards even though I’m far from rich, but that means I get hit worse at tax time. I had been contributing the 10% in part to try and keep my tax basis lower, and because I already make too much to contribute anything to my Traditional IRA anymore.

  4. Interesting dilemma, Jason. For most people Donnie is right, but you’re in a unique situation. The costs in the Bay Area are so much greater than the rest of the country (and the incomes are higher accordingly). I don’t think anybody would blame you for plugging more into the 401k over a Roth to reduce your tax basis a little bit now, even if the pure numbers suggest the Roth is the way to go (which I can’t say for sure). Good luck!

  5. Question: Hi all, I am hoping for a bit of insight – my company only matches 1% of my total contribution for my 401K. How much should i be contributing – with the current instability of the market. For the past 4 yrs i have contributed the max amount (15%) however now i am reconsidering – but looking for some professional advice. PLEASE HELP.

    THANK YOU

  6. Adding to the Roth IRA (if no matching) is good for at least 2 reasons. First you can choose where to invest, instead of being locked into the normally limited options for a 401(k). Also you diversify your tax risk. Since we are spending money we don’t have and creating huge unpaid bills that must be paid at some point it seems likely tax rates will rise. If that happens money in a Roth IRA will be more valuable than money in a non-roth 401(k) that you. Roth 401(k)s are starting to become popular.