Here is the next installment in our the Reader’s Questions Series which highlight questions emailed to me by you, the readers of Money Q&A. Be sure to find out at the end of this article how you can receive a free copy of Dave Ramsey’s book, The Total Money Makeover if your money question is chosen to be featured on the blog.
If you’re not familiar with Dave Ramsey’s book, you should run right out and get it. It is one of my top ten best personal finance books that everyone should read. Now….on to our reader’s question. I recently received an email from a reader, Ralph, who ask…
I’ve been investing more than my company’s match. So for instance if my401k company match is 5% and I invest 10%, is it better to continue or just invest the 5% that’ll get the match and invest the rest in a Roth IRA?
This is a great question that a lot of investors have to tackle when they are deciding where to put those finite investing dollars to work. You often can’t be everywhere at once.
So, the real question is where to start and where to go after you get going with your retirement investing. There are several things that you should consider in order to maximize your savings and minimize your tax liability as well.
401k Company Match Is Most Important
It is very important to invest enough money in your employer’s 401k retirement plan in order to capture your company’s matching contribution. This is essentially free money and a 100% rate of return on your investment.
Like Ralph mentioned in his email quoted above, he earns a401k company match on the first 5% of his income that he contribution to his 401k retirement plan. After putting in 5%, Ralph’s company gives him another 5% free, hence the 100% rate of return.
This is the typical agreement that many employers have with their workers who contribute to their 401k retirement plan. Offering the401k company match matching contribution is cheaper in the long run for the company that offering a traditional pension which is why it has become a very popular option.
But, now what should you do with additional investments over the 5%? Continuing to invest in your company’s 401k retirement plan after your initial 5% may not be the best idea.
Taxes Rule The Decision
Do you think that taxes will rise from now until the time you retire? Delaying the time that you pay your taxes into the future may not be the best idea if you are going to be in a higher tax bracket later in life when you withdrawal the money and owe taxes on it.
If you think that taxes will rise over your career and qualify to invest in a Roth IRA, you will most likely save more money in taxes investing money in a Roth instead of a 401k retirement plan. A 401k requires investors to contribute pre-tax dollars initially and then pay taxes on the total amount withdrawn in retirement.
Roth IRA contributions are invested initially with after-tax dollars from your paycheck that have already been taxed, and then your earnings and interest on your contributions can then be withdrawn tax-free in retirement.
The Final Word: Where To Invest
I personally think that income taxes will tend to rise over the long-term. Most young workers are typically in a low income tax bracket early in their careers, and the goal of everyone is to continue to earn more money throughout your careers in order to get into a higher tax bracket after earning more.
So, I typically recommend that people should always invest enough to capture their employer’s 401k company match. After that, if you qualify to contribute to a Roth IRA, then that should immediately be your next stop for an investment.
After you have captured your employer’s401k company match and matching contribution and maxed out your Roth IRA to the tune of $5,000, then you should consider investing more in your 401k. Until then, consider including your Roth IRA as fast as possible.
Past Readers’ Questions:
- How To Prioritize Which Bills To Pay First
- Should You Put Your Emergency Fund In Mutual Funds?
- How Do You Start Saving If You Live Paycheck To Paycheck?
- How To Find A Payment Plan Without Cutting Necessities
- Is My Money Save In A Bank?
- Is It Better To Save For Closing Costs Or Pay Down Loan?
- Is A $1,000 Emergency Fund Enough To Start?
- What To Invest In After The 401k Company Match
Do you have a money question that you would like to ask? Email me your money, investing, retirement, savings, or other question to Questions[at]MoneyQandA.com. If I pick your question for next week’s article in the series, I’ll send you a free copy of Dave Ramsey’s book, The Total Money Makeover, or you can pick from any of these other free books instead.