IRA, 401k, or Both?

Michael Cirelli |

A common question I'm asked is whether someone should be contributing to their IRA, employer 401k/403b, or should they do both?

Here are a few of the questions you should ask yourself first:

  • Does your 401k plan make matching contributions?
  • Up to how much of your contribution will they match?
  • After all expenses are paid how much money do you have to invest each month?
  • How long do you expect to be at your current job?

The first question that needs to be answered when determining where you should be investing your money is whether or not your employer is matching your 401k contributions. If they are, you want to contribute up to the amount that they match you and not a penny more. If your employer does not match your contributions then you would want to be contributing to your IRA/Roth IRA instead. When an employer matches your contributions that means they're giving you FREE money and you'd be a fool to pass up on that! When you receive no employer match on contributions in your 401k there's really no reason for you to invest your money there. It limits your investment selection to what's offered in the plan. An IRA gives you the freedom and flexibility of investing in many different financial instruments.

Now, if you're maxing out your IRA contributions each year ($5500 under age 50 and $6500 over age 50) then you would look to your 401k for additional means of investing for retirement. Again, there are far more benefits to an IRA than a 401k in my opinion, so unless you're making a full contribution to your IRA there's no reason to be contributing to a non-match 401k/403b plan. However, if you are currently maxing out your IRA contributions and looking for additional areas to save for retirement you can save as much as $18,000/year in a 401k/403b

Many employer plans that do offer a match incentive also carry a vesting element. Simply put, they require you to be employed with the company for 'X' years in order to receive the full value of your 401k. Any contributions you have made will always be taken with you if you decide to leave, but they can elect to withhold the portion they have contributed if you don't meet their vesting requirements. This is why the length of time you plan on being with a company is a factor when considering whether or not you should invest in their 401k. If you don't plan to stay with the company long enough to meet their vesting requirements, there's no sense in contributing to it, even if there is a match option.

In closing, the most ideal situation for anyone is to have the ability to make full contributions to their IRA each year while also contributing to their 401k. Unfortunately, not everyone has this luxury. Working with a financial planner allows you to budget your monthly expenses, determine the amount of match your  company plan offers and then decide how much, if any, amount should be allocated to an IRA.