Step 1 - Establish If You Are Eligible For An 401(k)
First, a 401(k) is only an option if your employer provides a 401(k) plan, or if you're self-employed and chose to set one up yourself. IRAs, on the other hand, are more broadly accessible - anyone of working age who meets certain conditions can open an IRA. An easy first step is to check if your employer offers a 401(k) as part of your employment benefits.
Step 2 - If You Have A 401(k), Maximize The Employer Match
401(k)s can come with a particularly valuable employer match. Under the employer match, your employer will match your contributions to your 401(k), either in full or in part, up to a certain level. This matching contribution is effectively free money and well worth taking advantage of. As IRAs are not employer sponsored, there is no equivalent to the employer match - the free money - for this investment vehicle. You should therefore invest in a 401(k) up to the matching level before you invest in an IRA.
Step 3 - Max Out Your IRA As A Second Priority
After you've taken full advantage of employer matching with the 401(k) it may make sense to use a IRA for the next tier of your retirement savings. IRAs offer meaningful flexibility in providing low cost investment options. Often 401(k) investment options are more expensive and less extensive. You can typically contribute up to $5,500 per year to an IRA if you're under 50 (and up to $6,500 if 50+).
Step 4 - Put The Remainder In A 401(k)
Once your IRA is maxed out, you should consider putting the remainder of your desired savings into your 401(k). For those under 50, the contribution limit is $18,000 - much higher than the equivalent IRA contribution limit. The 401(k) is a preferable investment vehicle, as compared to a basic brokerage account for example, given significant tax advantages.
Step 5 - Use Taxable Savings If Needed For Flexibility
Once you've maxed out your IRA and 401(k) - or if you may need savings for something other than retirement - you should then consider a taxable account for your remaining investments.
Step 6 - Obtain a Detailed Portfolio Allocation Recommendation
It is important to allocate investments across the accounts you have decided to open holistically, rather than simply considering individual savings vehicles in isolation. FutureAdvisor can give you a free recommendation on appropriate funds for your age and risk tolerance.
|Traditional 401(k)||Traditional IRA|
|Eligibility||Eligibility depends on employer, as 401(k)s are employer-provided defined-contribution plans||Any individual under 70 with taxable compensation is eligible|
- Age <50: $18,000 per year
- Age 50-65: $18,000 per year + a $6,000 catch-up provision per year
|- Age <50: $5,500 per year
- Age 50-65: $6,500 per year [capped at level of taxable compensation]
- Paycheck contributions may be made
either pre or post tax
- Earnings are tax deferred until withdrawals/distributions
|- Contributions are typically tax
deductible (up to a limit if total earnings are above a certain level)
- Withdrawals/distributions are taxed
|Employer Match||Employers often match a pre-selected percentage of each employee's individual 401(k) contribution||Not available|
|Investment Selection||Investment selection may be limited and often includes pre-packed products such as target date funds. Consideration of expense ratios and underlying costs is important||Wide selection of potential investments|