Michael on April 18th, 2008
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It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question.

If I can’t do both a maximum 401(k) contribution and a maximum Roth IRA contribution, what should I do?
—Beth M., Ramsey, NJ

STRAIGHTFORWARD ANSWER: Contribute to your 401(k) at least up to the point your employer matches. With additional funds available to save for retirement, contribute to the Roth. If there’s still money you can save after contributing $5,000 to the Roth, then return to 401(k) contributions.

More detailed explanation:

I love this question for two reasons.

First, asking this question shows your desire to understand of the best ways to save. Unfortunately for most people, far more time is spent debating whether to save in the first place. But by asking the question you have, it’s quite obvious that you “get it.”

The second reason I love this question is that the answer is fairly simple. What can I say? I like easy questions.

If your employer matches part of your 401(k) contribution, then your 401(k) is your best form of saving. Say, for example, your employer matches 50% of the first 6% you put into your retirement plan. If so, saving in your 401(k) instantaneously provides you with a guaranteed 50% return on your money. You put in a dollar and they add fifty cents. There simply is no better alternative out there. Period.

Even smooth-talking commission-obsessed financial salespeople have tough times winning arguments over that point.

The bottom line is that you should take advantage of an employer match. Rich people never turn down free money and neither should you.

Of course, it’s possible that Beth is already contributing up to the amount her employer matches. If so—and she qualifies for and can afford to save more for retirement—she should seriously consider contributing to a Roth IRA. A Roth IRA provides for tax-free growth of your retirement investments. While you don’t get the tax deduction you receive from a 401(k) contribution, the tax-free growth (as opposed to a 401(k)’s tax-deferred growth) makes the Roth a very attractive option. In fact, the younger you are, the more compelling a Roth IRA will be for you.

(If you are 50 or younger, you can contribute $5,000 to a Roth IRA this year (subject to income limitations based on filing status). If you’re over 50, you can contribute up to $6,000.)

If you still have money that you can contribute towards your retirement savings goals, increase the amount you save in your 401(k) plan above the match. Then give yourself a pat on the back. You’re doing really well.

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