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Where To Invest: 401k, IRA Or Both?

You know you need to save for retirement, but where do you start? Learn the differences between retirement savings accounts at work — like a 401(k) — and an individual retirement account (IRA) which you can open on your own.

Where should you start investing -- your 401(k) or an IRA?Decoding retirement savings is as thrilling as an all-day cram session for a standardized test. I get that.

But just like that grad school exam, your future depends on it.

A few weeks ago, I sent my focus group a quick survey on 401k plans. I knew 401ks are confusing—even to someone who’s been writing about them for years—but I was interested in what, specifically, you want to understand better about 401ks.

Over the next few weeks I’ll publish several posts that answer your top questions about at-work retirement plans. Starting with: Should I contribute to a 401k or an IRA?

Note: We’ll be talking about 401ks—the most popular at-work retirement plan. Non-profits and other institutions may offer 403b plans. Although there are some differences, if you have a 403b plan, most of what we cover will apply.

Today we’ll look at the pros and cons of a 401k or other retirement account at work versus an IRA that is a self-directed retirement account.

Save Something. Anything!

At work or on your own, everybody should save something for retirement. According to a recent survey, 55 percent of Gen Y have not started saving for retirement. No surprise. But we need to start. Look at the reasons people give for not contributing to their 401k:

401k or IRA? The top reasons people do not contribute to their 401k retirement plan at work.

(Are you eligible for a 401k or 403b but don’t contribute? Let us know why in a comment.

If it’s because of something you don’t understand, maybe we can help.) Of course, lots of young people simply don’t have the scratch.

It’s hard to set aside even $50 a month when Two-Buck Chuck is your go-to drink and your iPhone is still on your parent’s family plan.

Others are confused or intimidated by investing. Still more get paralyzed by questions like: “Should I use a 401k or IRA?” or “What mutual funds should I invest in?” What’s important is to:

Are there exceptions?

Only one: When you’re in credit card debt and paying interest over 10 percent. Even then, I wouldn’t fault someone for contributing a small amount to a 401k. Now that we have that out of the way, let’s look at the differences between 401ks and IRAs.

401ks vs. IRAs At-a-Glance

401k IRA
Employer-sponsored account Individual account
Annual contribution limit: $18,000* Annual contribution limit: $5,500*
No income limits Income limits may apply
Investment options may be limited by plan No limit on investment options
Can rarely be cashed out penalty-free except in retirement Can sometimes be cashed out penalty-free

*For 2015; savers over age 59 ½ are eligible to make additional catch-up contributions.

What a 401k Is (And Isn’t)

Before we dive in, there’s some confusion surrounding what a 401k plan actually is. One respondent asked:

“Wouldn’t it be better to do your own fund, such as a Roth IRA? I ask because with the current economy, many people I know lost up to half of their 401k.”

A lot of people think like this, in part due to the media commonly using people’s depleted 401ks as a sign of how the recession hurt everybody.

During the down economy, not everybody lost a job, but anybody with a 401k lost money. Only not everybody lost 50 percent.

Investors with who were properly diversified fared better. Both 401ks and IRAs are types of investment account.

The IRS gives investors in both 401ks and IRAs certain tax advantages over a regular investment account, and also sets rules for how they can be used.

It’s helpful to think of both a 401k and IRA as buckets with which you fill will rocks (investments like stocks and mutual funds).

Because everybody fills their buckets with different types and quantities of rocks, no two are the same. But this is where the similarities between 401ks and IRAs end. Let’s take a look at what makes a 401k different from an IRA, for better or worse.

401ks Have Limited Investment Options

With an IRA, you can invest in virtually anything. You can have an IRA that simply holds a savings account or an IRA with 100 different stocks, bonds, ETFs, and mutual funds.

You can even have an IRA that makes loans to other people through a peer-to-peer lending network.

With a 401k, this usually isn’t the case. Your employer partners with a financial services company to administer your plan. That company then gives you a limited number of investment options (usually, but not always, these are mutual funds).

If you work at a large company you may have a lot of investment choices. If you work for a very small company, however, you may only have 10.

For most people, having fewer investment choices is actually a good thing. Most people aren’t stock pickers and shouldn’t try to be architects of the perfect portfolio with hundreds of mutual funds.

The problem, arises, however, when 401k plans only offer mutual funds that have unnecessarily high expense ratios. If you work for a larger employer, you can research how your 401k stacks up in terms of investment choices and fees at Brightscope.

401ks Have Higher Contribution Limits

The whole point of 401ks and IRAs is that Uncle Sam is giving you a break on your taxes to encourage you to save for your retirement. Unfortunately, there’s a limit to this particular Uncle’s generosity: contribution limits.

And this is a big differentiator. In 2015, savers under 591/2 can contribute up to $18,00 to a 401k and up to $5,500 to an IRA. (For IRAs, this is an oversimplification, but bear with me.)

When you’re starting out, contribution limits are hilarious. There’s no way you’re going to come close to them. But as you earn more money, pay off debt, and get serious about saving for retirement, it’s another story.

Especially if you’re saving in an IRA alone, $5,500 may not be enough to fund the kind of retirement you’re dreaming about. Advantage 401k.

401ks Let You Contribute Pre-Tax Dollars

Normally, if you earn $500 and want to invest it in McDonald’s stock, you first have to pay income taxes on it. So you pay $100 of taxes and invest $400 in a stock. Assuming you hold this stock for many years, when you sell it, you’ll need to pay taxes on the amount the stock has appreciated…called capital gains tax, currently 15 percent. So if the stock goes from $400 to $600, you’ll pay $30 in tax. The $500 you earned (before taxes) has become $570 for a 14 percent post-tax return.

Now let’s say you invest the same $500 amount in a 401k. Now, with a traditional 401k, you don’t have to pay income taxes on money you put in. So you earn $500 and can invest $500. When it appreciates the same amount, you’ll have $750. But now, you have to pay income tax on the entire amount…not just the gains…$150. You’re left with $600…a 20 percent post-tax return.

Okay, so the extra $30 in this example isn’t impressive. But these are small numbers over a brief period of time. If that $500 were $500,000, that’s an extra $30,000 you get to keep.

Here’s another example:

401k retirement accounts compared to a taxable investment account.

*In our next post we’ll take a closer look at how Roth accounts—both IRAs and 401ks—compare to their traditional counterparts.

401ks and IRAs Have Early Withdrawal Penalties

Here’s the thing about retirement accounts: They’re meant for retirement. The tax breaks Uncle Sam provides us on money saved in a 401k or IRA are incentives to save for retirement. So he also provides an incentive not to touch that money.

This is the early withdrawal penalty.

If you withdraw cash from a traditional 401k or IRA before you turn 591/2, you will owe a 10 percent penalty to the IRS on top of ordinary income taxes.

IRAs provide a bit more flexibility in this arena, and there are a number of exceptions to the IRA early withdrawal penalty. You can, for example, use funds to cover higher education expenses and up to $10,000 towards the purchase of your first home.

With a 401k, you must prove severe financial hardship to obtain an exemption from the early withdrawal penalty.

Some employers, however, allow you to take out a 401k loan. Essentially, you borrow money from yourself. Although this sounds like a great idea, it’s a slippery slope. Any money you borrow ceases to earn returns for you and, if you lose your job, you must repay the entire loan or pay income taxes and the 10 percent penalty on the outstanding balance.

The Bottom Line

The decision to invest in a 401k, IRA, or both is different for everybody and depends on another set of circumstances: Whether you are eligible for either a Roth 401k or Roth IRA. We’ll talk about that next time.

In the meantime, I will say this: for those eligible, 401ks are the easiest way to save for retirement. The limited investment choices can be a good thing because it simplifies your investment decisions, and the money is automatically taken out of your paycheck.

Some employers even match some or all of your 401k contributions up to a certain limit. So if your employer offers a 401k plan and you’re eligible, you should contribute to it. If they offer a plan with matching contributions and you don’t take advantage, you’re passing up free money!

If you don’t have access to a 401k—or maxed one out—-and still want to save for retirement, you should open an IRA. In a few days, we’ll take a look at another common and confounding question: When given the choice among a Roth 401k, Traditional 401k, a Roth IRA and a traditional IRA, which one(s) should you choose?

We’ll also cover how much you should be contributing and how to select investments to obtain the right asset allocation.

What about you? Do you participate in your company’s 401k or 403b? If not, why? Let us know in a comment.

Published or updated on December 15, 2013

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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.


We invite readers to respond with questions or comments. Comments may be held for moderation and will be published according to our comment policy. Comments are the opinions of their authors; they do not represent the views or opinions of Money Under 30.

  1. Kristen Bush says:

    Hi there- I am 26 years old with student loans with no other debt. My current employer does not match 401K, but I do have an existing from an old job. What advice do you have for contributing to 401K if employer does not match with a considerable amount of student loan debt?
    Pre-tax income is about $55,000 with $20,000 in student loan debt

    Thank you!


  2. Judy Shufelt says:

    I am self-employed and would like to open a 401k. I have a lump sum to deposit in this new account. I currently have a Roth IRA and an individual investment account. I am not sure how to go about opening a 401k as a self employed person nor do I know how much I can contribute annually ( I assume based on business income) or how much I can place in this account at its inception.


  3. Francesca says:

    I cant decide on an IRA or a 401k I don’t really plan to use this for my retirement as this isn’t the career im going to stay in I just want to save up and borrow it back as a down payment on a house within 18 months. Which should I use? 401k has my employer matching it while IRA is better to borrow for my house.

    • TripM says:

      Francesca, go ahead and take advantage of your employer’s matching benefits because YOU CAN BORROW FROM YOUR 401 K if it is your first home and if there is any money left, you can still roll it over to your next employer’s 401k or to IRA of your choice.

  4. Randy Duke says:

    Starting a new job.Have $20K in an old 401k. Still dont know whether to roll into my new 401K or start a new IRA??????????? Thanks

    • Mathew says:

      No question about it. Start an IRA. Lower cost and more investment options. Not to mention more control over what brokerage company you use. Could even invest in an alternative asset through an IRA (such as real estate or a private company).

  5. Lynn says:

    I put in 16%, my employer matches up to 8%, then the company gives me 9% for a retirment fund in addition

  6. ED says:

    I am a married 34 years old man with 1 kid and don’t have any retirement plan set yet. I would like to start. But not sure what my options are to enroll in 401K or IRA. I would like to save some taxes as well. Here are my numbers:

    Salary: 95,000K/yr

    Stocks: 85,000K “at the moment if I sell all my stocks that’s the number I get. But it could be higher or lower”

    Saving: 30,000K

    My employer does match to 4% for 401K

    Any suggestions?

  7. Carrie says:

    I’m a stay at home mom, and my husband makes 62K a year. I know you can only put money that you’ve earned into an IRA. Can we open two IRAs, one in his name and one in mine? His employer doesnt do % matching on the 403b, so if we could max out one Roth and the put some more in a second one, that’d be ideal for us. Thanks!

  8. Austin says:

    I’m about to turn 24 and make $60k a year. I am currently setting aside 10% for my 401(k) with a full match up to 6% from my company. While I believe this is a good start, would you suggest that I open a Roth IRA to hedge future tax increases that are bound to occur within the next 40+ years before my retirement?

    • Josh says:

      Austin- Absolutely open a Roth. You want to be as prepared as you possibly can for any increases (very likely) or decreases in taxes that are to come when we are in retirement (I am 23). This way if when you are 60 years old and want to start your retirement withdraws when the taxes are outragiously high, you can have the ability to pull tax free money from your roth. Then if the tax rates lower, pull money from your taxable 401K.

  9. Mathew says:

    I would like a little general advice on my situation. I sort of think I might be putting too much in retirement accounts if that is possible. I am 25 years old and currently make 66K a year plus a bonus. I maxed out my Roth IRA with 5k for 2012 and put $1,000 a month into my 401k. I will be getting a bonus this week of somewhere between 10K-15K and plan on putting 3K-5K into my 401k. Therefore I will be putting at least 15K and maybe up to the max of 17K into my 401k in 2012. I also expect to receive a raise in August that could allow me to max out the 17K even if I only put the 3K in my 401k now. I am wondering if I am being too aggressive and if maybe I should create a separate taxable brokerage account (I already have investments and savings outside of retirement accounts) that I kind of earmark for retirement. Any opinions on this would be greatly appreciated.

    Thank you

    • Colin says:

      Hi Mathew,
      Personally, I see nothing wrong with maxing out both the Roth IRA and 401(k). I’ve been doing maxing out in my 8 years of post-college employment and still have been able to save in a separate, taxable brokerage account. Granted, I’m not sure what the cost of living is in your area of the nation and how lavish your living arrangements are, but you should be able to manage.

      You’ve stated that you’re socking away $1000/month into your 401k, so hypothetically you’re committed to putting in $12,000 so far. With your bonus, you’re planning to put in another $3-5k…for example’s sake, let’s say you just put in $3k, so now you’re at $15k. Assuming you’re paid biweekly and depending on where your paydays fall on the calendar, you probably have 15-17 pay periods left in the year and only $2,000 more you can contribute to hit the $17k max, you’ll only need to put $133.33-$117.65 more per paycheck (and this is before your expected pay raise which would lower that amount).

      Thus, if you can afford a paycheck that’s $100-150 smaller than it currently is now, I say go for it, max out, and take your bonus pay & pending pay raise and either cut personal costs or just resist the urge to spend for several pay periods and you’ll have a nice chunk of money you can invest in an individual account.

    • Colin says:

      As another side note…nobody in retirement says “I wish I saved less” but plenty say “I wish I saved more”. I know people will argue you need to live life now b/c there may be no tomorrow, but based on probability, you’ll probably see tomorrow and about 50-60 more years of tomorrow as well.

      • Mathew says:

        Thanks for the input. I probably won’t be able to increase my per paycheck contribution (fyi I get paid semi monthly) especially during the summer as I usually spend about $100-$200 more a month during the summer. I think I will just put as much of my bonus into the 401k as I can and then see what the raise is and hope between the two I can max out in 2012.

        • Colin says:

          That sounds like a good idea Mathew. I do the same with my yearly bonus…I increase my contribution percentage up to the maximum in my plan (60%) so that way a good chunk of the $17k yearly max gets taken care of with my bonus and my biweekly paychecks are bigger since I don’t have to contribute as much for the 26 biweekly pay periods a year. I budget my expenses as if I’m not getting a bonus (though we always do), that way when I know what my bonus is, I know I don’t need that money and can dedicate 60% of it to my 401k instead and have bigger paychecks during the year.

  10. Joann says:

    I am always debating if I should just stop contributing to my 401k . With the rising debt of the US, they will increase taxes for sure. I think it might be wiser to just take the money now instead of deferring it until i’m 59..

  11. Colin says:

    Another quick question David, you state in this post, at the end, “In a few days, we’ll take a look at another common and confounding question: When given the choice among a Roth 401k, Traditional 401k, a Roth IRA and a traditional IRA, which one(s) should you choose?”

    Do you plan to talk about tax diversification too? In other words, having some retirement money that is diversified as far as the tax repurcussions? Since no one knows what the tax laws & rates will look like in 30-35 years, it may not always be a good idea to have Roth 401ks & Roth IRAs if tax rates are lower than they currently are in the future (though I strongly doubt it)

    • David Weliver says:

      Hey Colin, Thanks for your comments and questions. I hope I addressed the one about tax diversification a little bit in today’s post comparing Roth 401ks and traditional 401ks; I agree that a mix of both isn’t a bad idea.

      I recall seeing your questions about employer matching when you max out the 401k in less than 12 months and I haven’t been able to find an reliable answer yet. I have a hunch though that it might depend on the individual plans so you might want to check with your benefits office. I’ll report back if I find anything.

  12. Colin says:

    Hey David, perhaps you can shed a little light into this (maybe not) but in another blog entry, I had a disagreement with another commenter about employer matches.

    He was stating that if you’re contributing to a 401k and plan to contribute the 17k max, you should do it early in the year as then they’ll experience the longest # of months to grow (and capture any quarter or mid year dividends) and the employer will still contribute after you maxed out.

    I argued that I’ve never heard an employer continuing to contribute if you’re no longer contributing. If I max out my 401k contributions at the end of August, do any employers continue to contribute after you’ve reached the match?

    I guess my argument was, an employer only matches when you’re contributing, hence, if you plan to max out your contributions by August, they’re only matching you for 8 months you were contributing and that they wouldn’t match September-December since there isn’t anything to match (b/c you’re not contributing).

    Who is right or are we both right and wrong?

    What I do is take the $17,000 and divide it by 26 bi-weekly pay periods to figure out how much I need to contribute bi-weekly to reach the max and then take that bi-weekly amount divide it by my pre-tax, pre-deduction pay amount to determine the contribution % I need to report to my brokerage & employer to take out of my bi-weekly paycheck.

    • Colin says:

      Sorry, in the 3rd paragraph in the last sentence, it should read “…contribute after you’ve reached the max” (as in the 17k max)

  13. AJ says:

    I’m 24 and make $40k investing 5% of my income with a full match up to 3%. I find that the match is what makes my 403b worthwhile. Now that I have a sizable emergency fund, I have started putting half as much into it and the other half into my Roth IRA with Vanguard. I’m just not sure if it should be my priority to put more into the roth or into the 403b since I only need to put 3% in to get the full match and it’s a relatively strong plan.

    • Mark says:

      Contribute enough to get the match, then put the rest into your IRA. You only need to start putting more into your 401k when you have maxed out your IRA and still want to contribute more.

  14. David Weliver says:

    Ack, employer matching on 401ks was a HUGE omission. My bad.

    Yes, if your employer matches 401k contributions this is a big advantage to the 401k that you can’t get with an IRA. Which is why I say, in general, even if you want to go with an IRA for other reasons, if your employer matches contributions, contribute enough to the 401k to get that match! Not doing so is literally leaving free money on the table.

    For those unfamiliar, a 401k match is an employer’s way of encouraging you to save for retirement that’s part of your compensation package. Usually, your employer will match what you put into your 401k up to a certain cap. They match dollar for dollar or $0.50 for every $1 you put in.

    For example, if they match 50% up to 6% of your salary, you earn $50,000 and contribute 10% to your 401k…you contribute $5,000 to your 401k, your employer matches $3,000 of that at 50% so they contribute an extra $1,500.

    If you only contributed $1,500 (3%) of your salary, your employer would only kick in $750. So that’s why you always want to take advantage of the match.

    Now, matching programs bring up vesting, which deserves its own post. The quick version is even though the money from your employer goes into your account and starts earning returns, if you quit before you’re “fully vested” you don’t get to take ALL of that money with you. As a common example, the money may vest over 5 years, so each year you work there you’re another 20% vested. If your employer contributed $1,000 and you quit after a year, you only get to take $200 with you. (Note that this only applies to your EMPLOYER’S money, not your own!)

  15. Cynthia says:

    What I don’t care for in a 401k account is that you can only make money if the market is bullish. Why can’t they develop a plan that people can make money in a bearish downtrend scenario. I am currently managing my own 401k account moving money in the best performing investments within the limit of twice a month. If I decide to go to cash I have to wait 30days before I enter in again. Do you have any suggestions on how I can better manage my account to maximize profits and limit losses. I am open to any suggestions, please be detail if at all possible.

  16. Michelle says:

    Thanks for making me feel a little better about how the limits are considered hilarious to those just starting out, that’s exactly how I felt back in those days. In my twenties I did save something to both a 401k and Roth IRA but certainly didn’t know much or understand how to invest it better. Plus I spent all of my twenties trying to pay off debt so I felt I couldn’t contribute much but thankfully I contributed something, I knew enough to understand it was important and to never ever touch it. Now that I am 33 I am finally maxing my Roth IRA and contributing up to my employer match in my 401k. I can’t help but feel like I missed out in my twenties and want to know if I’ll be ok now that I am finally properly saving for retirement at 33. I have about 70k in my 401k and about 8k in the Roth IRA. I look forward to reading your next article on investments as I am still learning about EFT’s within my Roth IRA. I currently use the Money Navigator guide from Suze Orman to help me with this.

  17. John says:

    Great article! When I first started working I was self-employed and a friend helped me set up a Roth IRA for retirement. I now work a more traditional job and contribute to a 401k. I put 6% (and get 3% match from my company) of my paycheck a month toward my 401k. I also put $200 a month toward my Roth IRA so that can continue to grow, but I struggle with whether or not that’s the best decision. Should I continue to contribute a little bit to both accounts, or try to put everything I save a month into one account so that it grows faster? And, if I put everything that I save into one account, which one do you recommend? Thanks!

  18. Drew says:

    I think a big thing you missed out on is the employer match on 401(k) accounts. I know not every company offers a match, but that is the biggest driver for investing in a 401(k). An employer match is ‘free money’ or really free gains. So if you have any employer match, then the 401(k) is the superior ivestment vehicle since it offers an instant and usually significant return on your investment.

    If your employer does not offer a match, then there is no reason to contribute to it since it is essentially an IRA with far less investment choices and stricter rules for taking early contributions. You would be better off with an IRA.

    If your employer does off a match, then you should contribute the full amount that they will match, but no more. Anything beyond that is better served in an IRA where you have more options and easier access.

    For instance my company 401(k) offers a 100% match on up to 6% of my salary and then they give an extra 1% match on top. So if I contribute 6% of my salary, they match it with 7% of my salary in company stock. However, the drawback is that we are limited to a choice of company stock, 4 stock mutual funds, 1 bond fund, and 1 money market account. So I have my 401(k) contribution set up at 6% to take advantage of the generous match. However, I still want to save more. I then have a taxable investment account where I put 40% of my post-tax salary. I use a taxable account because my income is over the limit to be able to take advantage of Roth IRAs and even traditional IRAs (mostly because I am single and there are lower limits for singles). So there is no tax advantage to an IRA for me and it would only lock up my money until retirement, so I like to have total access to money at any time.

  19. Sara says:

    I work for the public school system in Pennsylvania. Our only option is PSERS, and I’m contributing 7.5%, but I’m honestly not sure what type of retirement account it is. I started contributing to a 403(B) about five years ago, but now I’m wondering if I should look into a Roth IRA?

    • Drew says:

      Roth IRAs are the aboslute best option out there. The reason is twofold:

      First and foremost is the tax advantage. Even tough you pay taxes up front, that is all you pay. When you take that money out at retirement, it comes out tax free. That means that all of the gains go untaxed. This is esprecially advantageous if you expect either to be in a higher tax bracket (i.e making more money in the future) at retirement or if you think tax rates will increase in the future. You are much better off paying 20% tax on $500 today than paying 20% tax on $50,000 at retirement.

      Secondly, being an IRA, you have more investment choice than in the 403(b) and less restriction on taking early contributions.

      The only catch to this is your age. If you are young, then the Roth IRA is a no-brainer. But if you are close to retirement, then the Roth may not be the best choice because in a short time frame the funds that you pay in taxes on a Roth could have been invested and earning returns. Given that you are probably in your final tax bracket, there won’t be any savings and you will give up the returns on the amount that you paid in taxes on the Roth.

  20. Brett says:

    I am 27 and gross around 32k I put money into my Roth IRA at Vanguard because my company does not have a 401k match. Where should I put my money?

  21. Mish says:

    I am 23 years old and make $30,000. I work for a non-profit that offers a 403b- Plan. I contribute 5% of my salary which is about $100 a month to a fixed account. I’m also paying down my student debt. Any exclusive tips, advice/info for 403b plans?

  22. Cee says:

    Great article and thanks for sharing. I currently contribute only to my company’s 401K. I’m often one whose confused or intimidated by investing. I don’t know much about it and I’m learning as I go. I look forward to more post about 401K and IRA.

  23. Mark says:

    I have both a 401K and a Roth IRA however I’ve stopped contributing to the Roth IRA. My thinking is that I get a better return focusing on my 401K. I understand diversifing but I don’t know if diversifing between a 401K and a Roth IRA is really diversivification. I save 10% soley into my 401K now, is this thinking correct or should I match my companies contribution to my 401K and start maxing out my Roth IRA?

    • Mark says:

      Diversification has to do with type of investment, (bonds, large cap stocks, small cap stocks, international stocks, commodities, etc.) and has nothing to do with 401k vs Roth IRA. IRAs give you more flexibility for investment options, but if that isn’t an issue for you then it just comes down to whether or not you think your taxes will be higher or lower in retirement.

  24. Hayley says:

    What if my employer just became an ESOP and no longer contributes to a 401K, although they still offer it? I am a 26 year old and stopped contributing for a year after previously adding up to $1800.

  25. Brent says:

    Great article. I have been trying to figure out the specific differences between the two. Thanks for the great information and advice!

  26. Adam says:

    I make 65K a year and contribute 24% to my 401K and automatically withdraw $416.50 to my Fidelity Roth IRA every month. I am 28 years old and currently single. I figure when I purchase a home or have a family my contribution will decrease dramatically so I better contribute as much as I can now and let it grow!

    The key for me was 18 months ago I was making 55K and I got a 10K raise. I increased my contribution right away from 10%-24% and DIDN’T notice anything change because I was earning more. I haven’t changed my spending habits much over the years and its paid off by allowing me to contribute more…

    The key is making automatic investments into your 401K and Roth IRA so you don’t really notice its gone and don’t have the chance to spend it. Right now I sometimes wish I had more spending money but I think 30 years from now I will really appreciate what I did in my 20’s

  27. Thank you so much for this post, particularly the “401k(s) Versus Taxable Investment Accounts” chart. Looking forward to the closer look at how Roth accounts—both IRAs and 401ks—compare to their traditional counterparts.

  28. Adam says:

    I didn’t see anything about the fact that a 401k usually gets a matching contribution from an employer…. do IRAs get the same treatment commonly? If not – point for the 401k.

  29. I contribute to my 401(k), it’s free money in my head. Plus, having it come out of my paycheck before I even see it helps.

  30. Tracy says:

    I contribute to a 401K, Roth IRA and have credit card debt- I thought I was on the right track but now I am scared that I may have bitten off more than I can chew. I am determined to pay of credit debt before marriage (hopefully the purchase of a house too) But with the recent economy- I am just way too scared to be broke when I am old

  31. Lindsey says:

    This post is great. I’m about to start saving for retirement. I’ve been trying to decide whether to start with a a Roth IRA or to contribute to my company’s 401k. I don’t actually plan on retiring in the traditional way since I’ll be staying at home when I have children, but my husband will be retiring and I want to start saving for our future now while I’m still working. I’m not sure if that would factor into which kind of account to choose.

  32. Mark says:

    Nice article David. I contribute to both a traditional 401k and Roth IRA to try to hedge my future tax liabilities. Now that I’m in a higher tax bracket than I was in college, I probably invest 2/3 in a 401k and 1/3 in the Roth. I hope that I’ll be in a lower tax bracket when I’m retired, but with our national debt and tax code, who knows what taxes will be like in 30+ years!

    Quick note: on the 401k vs Taxable Investment Accounts chart, I believe the After Tax Value of the 401k should also be $16,000, as the entire 401k portfolio is taxed at 20% not just the earnings.

  33. Scott Smith says:

    I don’t contribute to a 401k offered by my employer. I opened a traditional IRA recently through USAA, and plan on contributing small amounts into that monthly. Here’s my reasoning:

    1) I’m 36 and my family history shows my life span isn’t going to be much beyond 70.

    2) My wife is 24, whose father is 68 and has Altzheimer’s. It’s a strong possiblity she’s going to need care before retirement age as well.

    I hate to think so pessimistically, but I’m an analyst, and the statistics don’t look favorably on us having a traditional retirement, so why should we be pouring a ton of money into something that we’re highly likely to need well before it? If anything, I wonder if we should be pouring our money into a HSA instead?

  34. Rob says:

    I contribute to my 403(b). I started because my company offers a match up to 6%, so I figured I’d be throwing away free money if I didn’t. As long as I work at this company I’ll probably never be able to afford maxing my 403(b), but I’ve got at least 40 years until retirement, so I’m not bothered by that.

  35. Chris says:

    Excellent article. I am trying to figure out which retirement account would be best for me: Roth 401K or Traditional 401K? I am 23 years old earning $60K.

    I think that the Roth 401K would be the best option for me because that means my earnings will grow free of tax but I could be wrong because the table in the article seems to indicate that the after-tax rate of return would be higher with a Traditional 401K?


    • Rob says:

      Unless you live in a very expensive city, that income will probably go pretty far. If I were you, I’d probably try to max out both accounts. If you do this every year until you turn 30, then 30+ years of interest will get you pretty far, even if you never contribute another penny.

    • David Weliver says:

      There’s an error in that chart I missed and will fix…all things being equal, the after-tax return of the Traditional 401k and Roth 401k should be the same. As I’ll cover in the next post in this series, there are situations in which one ends up better than the other, it all depends on the tax rates you pay now and the tax rate you’ll pay in retirement.

    • Steve says:

      you can’t max out both a traditional 401k and roth 401k, it’s 17,000 to one or the other, or possibly split between both. The total amount invested is the limiting factor, not which account it goes into. You can also invest 5,000 in an IRA, roth or traditional, but 5,000 is the annual dollar limit for individual accounts.

      The table in article is based on a 10 yr time frame. Being 23 yrs old, you should probably think more like a 40 yr time. Based on the assumptions for that table, (6.5% return, 10k/yr) you would do about 33% better to contribute to the roth (retirement value of 141k v 188k). And this is based on the assumption you’ll pay 25% taxes in retirement, which means taxes don’t increase from 25-28% at the end of this year, as scheduled, or go up at all over the next 40 yrs, from the historically low rates we have now. It also assumes you don’t end up in a higher tax bracket later in life because you were extraordinarily successful. Paying a 30% tax rate in retirement makes the roth even more attractive (131k v 188k). You can play around with the numbers yourself, the schwab website has a good one, just google “roth or traditional calc”.

    • Monica says:

      Another nice thing about the Roth is you can take out the original amount without penalty (but not the interest). So I also think of it as a good last-resort emergency fund….

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