Among the many decisions we all must make about retirement, one of the most perplexing relates to the types of retirement account options. For many of us, there are a lot of choices including a 401k, Roth 401k, Deductible IRA, Roth IRA, and a Non-deductible IRA. And that’s not even counting 403b accounts, SEP IRAs, Self-Directed IRAs, and of course taxable accounts.
And if that weren’t enough, for many of us the best options are a combination of 401k, IRA, and taxable accounts.
Recently I came across a post on the Bogleheads forum (an excellent investing forum) that addressed this question. According to the good folks at Bogleheads (named after the founder of Vanguard, Jack Bogle), retirement investing should be placed in the following types of accounts in the order listed:
1. 401k/403b up to the company match
2. Max out Roth IRA
3. Max out 401k/403b
4. Taxable Investing
401k/403b up to company match
When your employer matches some of your contribution, it’s critical to take full advantage of the match. Otherwise, you’re just turning away free money. The value of the match makes this the first place to stash your retirement savings.
Once you’re saving enough in a 401k to get the company match, additional retirement savings should go to a Roth IRA, according to the Bogleheads. While I think arguments to the contrary could be made here, I like this approach for two reasons.
First, most generally assume that taxes will go up in the future. So unless you are in the top brackets today (2011 tax brackets; 2012 tax brackets), many recommend paying the taxes on the income now, and enjoying tax free growth and retirement distributions later with a Roth IRA. And with retirement savings in both a 401k and Roth IRA, you have some investments that are tax deferred and some that grow tax free, which is a nice way to hedge your bets when it comes to future taxes.
Second, with any IRA, you can choose where to open the account. Many 401k plans charge extremely high fees and have limited investment options. For those who like to keep investing simple, Betterment is an excellent option for an IRA (read my review here). If you like to trade, I think Scottrade is a great choice because of low fees and physical branches just about everywhere, but there are many brokers that offer IRA accounts.
Keep in mind that your income may disqualify you form opening a Roth IRA. You can check out the 2012 Roth IRA limits here.
Max out 401k/403b
Once you’ve maxed out your Roth IRA, then top off your 401k. Keep in mind the limits on contributions, which can change from year to year. For 2012, the contribution limit has been increased from $16,500 to $17,000. The catch-up contribution limit for those aged 50 and over remains unchanged at $5,500.
Unless you qualify for a SEP IRA, the next and last stop is a taxable account. Here you can open an account with a mutual fund family like Vanguard or Fidelity, open a brokerage account, or use a service like Betterment.
As I mentioned above, every situation is different. The above priority list may not be ideal for everybody. But I think it’s a sound way to approach retirement investing.
Published or updated April 11, 2012.