401(k) vs. IRA – Which is Better For Your Extra Money?

401(k)s vs. IRAsOnce you’re contributing up to your company’s 401(k) match, do you continue upping the % or do you jump to the IRA?

This is one of the questions I get asked the most as a PF blogger (the other is probably how to start blogging or the order to pay off credit cards), and it usually comes down to personal preference. Since I mostly respond back the same way all the time, I figured I’d copy & paste the question and my answer below and see if maybe YOU have some better advice on it this time around? That way I could refer them back to this post in the future :) Here’s the question from Mr. Wants-to-take-advantage-of-retirement-plans:

“I’m like you, turned 30 this last year, and getting my finances in line (I’m in the black, which is a good thing, but I can do better)….got a question for you regarding 401k’s and IRA’s. I currently participate in my companies 401k program, but I am only contributing the amount that the company matches (i.e. 60% on my first 6%…). However, my 6% doesn’t even get me close to my annual maximum ($16,500 or so… whatever it is…(J: Yup, that’s correct!)).

Would you suggest hitting the $16,500 in my 401k before setting up a separate IRA account? Or would you just contribute to the 401k up to the employer match amount, and then max out an IRA each year?”

First of all, GOOD WORK on matching up to that 6% already – 90% of people never even consider it. Second, I like that you’re asking this as a lot of people wonder the same thing (me too, at times) and to be honest it’s a tough call. You’re right in that I’m not a professional, so I can only tell you what I would do in your shoes :) And that would be to compare the funds available in your 401(k) vs. the IRA, or even better, Roth. The Roth is the bad boy these days and much more pimped out than the Traditional – but still do your research to make sure it works for ya.

But back to the funds. *Most* 401ks from smaller companies usually suck as the funds to choose from aren’t as good as if you had the open-sea of EVERYTHING out there like you do with IRAs. My company has a great match at that 100%, but the funds are pretty shitty from what people tell me. So, if I were only getting the 6% match then I’d do that, or maybe even up it to 10% to keep it even (I always round up) and then work on maxing out my Roth. This way, you could pick much better places to put that money and in all types of products – mutual funds, stocks, bonds, whatever you want really. It might depend on which institution you go to open one up, but it’s nothing Google can’t help you with. I’d start at Fidelity or Schwab and go from there. (Or, USAA if you qualify – that’s who I use for my Roth) .

Not only should your money get into better places this route, but you hit that max a lot quicker giving you that feeling of Awesomeness. The Roth & Traditional IRA max out at 5k this year, so you could break up the payments from now until the end of the tax year to make sure & evenly distribute the money until maxed. In all honesty, you’ve already gotten 80% of the smart investing part down as either route you take is bad ass :) But that’s what I’d do – keep your 401(k) contributions to 6-10%, and throw the extras into an IRA. What would you guys advise?

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  1. Bill Phillips March 28, 2011 at 6:09 PM

    As you mention 401K options rarely offer the best investment choices available, but pre-tax verses post-tax investments towards retirement, both have their place.

    At the very least make sure you take advantage of your company match as stated. Pre-tax dollars can actually grow faster in a neutral (given the same returns) environment, well because obviously the money has yet to be taxed, and there is more of it at work for you. Another advantage of 401K is the autopilot mode of deducting from your paycheck. It is undoubtably a cliche but you don’t miss what you never see. Although 401K’s have limited choices, for individuals without a lot of investment experience, learning how to make those choices work best for you is a good introduction to investing.

    If indeed you are on track to have your 401k meet your objectives as J Money has provided ample resources to determine, then go Roth IRA. To invest in a traditional IRA would be redundant to the 401K plan you already have. And there are sooooooooooo many advantages to a Roth. J could do an entire section on this area.

    But I always reassess the portfolio mix quarterly for the 401K, and even though the investment choices are not now what I would have available in a IRA, I get to roll over the total balance if I leave the company (albeit a regular IRA). At least I have managed in the meantime to build a nice healthy balance to really put to work.



  2. J. Money March 29, 2011 at 2:58 PM

    Thanks Bill! Glad you chimed in here ‘cuz all our comments got deleted when we made the Blogger –> WordPress change last year :( You’ve said it well my man, appreciate it.