What to do first when it comes to saving for retirement
As you consider your goals for the New Year, I hope one of them is to save for retirement. But with so many different ways to go about it, you may be left with one question: What do I do first?
Here’s a suggested list, in order of priority. Even if you can tackle only the first or second step below, that’s a great start. If you can go further, even better!
1. Contribute to a 401(k) with employer matching. Many companies reduced or suspended matching mid-recession, but if you’re lucky enough to work where this is offered, it’s the best deal around and, therefore, your number one priority. The match alone can generate an immediate 50% to 100% return on your money (once you’re vested), and either flavor of 401(k)—regular or Roth—provides years of tax-advantaged growth. Don’t put money in any other retirement account until you have reached the limit of what your employer is willing to match.
2. Open an IRA (Roth or fully deductible). If you’ve reached the match level on your 401(k) or your employer doesn’t offer matching, consider one of these two options. Your eligibility depends on your income level, whether you (and your spouse) have a retirement plan through work, and other factors. A Roth IRA offers completely tax-free growth forever, but you don’t get to deduct your contribution from your income; a fully deductible IRA offers years of tax-deferred growth (you pay taxes when you withdraw), but you can deduct your contribution from your income. IRAs also allow you to withdraw money penalty-free to buy your first home or pay for educational expenses. (Discover the best way to open an IRA.)
3. Open a partially deductible or nondeductible IRA. If you have contributed the maximum to your 401(k) that your employer will match and you’re not eligible for a Roth or fully deductible IRA, this is your next best choice. The reason: Tax law now allows you to convert any IRA into a Roth IRA. (To see which IRA options you’re eligible for, use Smart Money’s calculator.)
4. Contribute to a 401(k) without employer matching. If you’ve already contributed the maximum to options 1 through 3 above, try to max out your 401(k)—even if it’s a stretch on your budget.
5. Save beyond a 401(k) or IRA. Once you’ve exhausted your tax-favored savings options—IR As and 401(k)s—you’ll have to save in bank accounts, money funds, and other types of mutual funds in the regular old taxable way. But if you invest well, you’ll be thankful down the road. (See my top tips on investing.)
What priority would you like to tackle in the New Year?