On the first week of your new job, the company's benefits coordinator asks if you want to contribute to its retirement plan. You want to do the right thing and start saving for retirement. But is the company's plan your best option?
A number of accounts are available for your retirement savings. Many companies offer a retirement plan known as a 401(k) (or 403(b) if you work for a nonprofit organization). Then there are individual retirement accounts (IRAs). Here's how to decide where to stash your cash.
For many people, the first priority for retirement saving should be investing in a 401(k). That's because these plans have an unbeatable combination of advantages.
First, your 401(k) contribution is made before you get your paycheck -- in other words, before your paycheck can get taxed. So every dollar you contribute to a 401(k) is a dollar you avoid paying tax on. The more you invest, the lower your tax bill. What is more, your company will deduct your contribution from your paycheck, so you avoid being tempted to spend.
Another great thing about a 401(k) is that most employers make a matching contribution. Your company may contribute, say, $.50 for every dollar you put in your account. That's free money -- and we all know that free money is pretty hard to find.
Because of the 401(k)'s combination of virtues -- tax savings, matching contribution and regular investing -- it should be your priority. If your company has a matching contribution, try at least to contribute enough to earn the company match. Once you have, you can continue to contribute up to your plan's limit. (The government caps contributions at $10,500 annually, although your company may have lower limits.) That may be a good move if your company has a good plan, with a wide selection of mutual funds that perform well. But if your 401(k) fund options are limited and do not allow you to properly diversify your holdings, consider opening an IRA.
When You Need an IRA
An IRA allows you to invest your money more freely than a 401(k). Instead of being limited to pre-selected mutual funds, you can put the money in your IRA account in any investment vehicle you choose -- stocks, funds or bonds.
Although your IRA contributions are limited to $2,000 and in many cases are not tax-deductible, there are good reasons to have an account. You may want to open an IRA if your company makes you wait several months before you are eligible to contribute to its 401(k). While you are waiting, you can still make an IRA contribution in the current tax year. You may also want to house your savings in an IRA if you change jobs frequently. When you change jobs, you have the option of moving any money in an existing 401(k) account into a rollover IRA.
You can open an IRA at just about any bank or brokerage. Financial institutions charge an annual fee for handling the account, which averages about $10 to $45 a year. Check your local newspaper or search online for banks and brokerages that charge low rates.
Now that you know the options you have, find out how to choose the right funds: