Q&A: Smart ways to save for retirement
The fact that your potential employer offers a 401(k) is a great, says Fritz Wood, CPA, CFP, a financial consultant and owner of H.W. Wood Consulting in Lake Quivira, Kan. Your plan allows money to be deducted from your paycheck and deposited into your 401(k) before tax. So, if you contribute $500 per month ($6,000 per year) and fall in the 30 percent tax bracket, you'll save $1,800 annually in income taxes. Furthermore, your $6,000 grows each year without taxation—you pay tax upon withdrawal. Finally, you might enjoy an employer match. Very commonly, to incent your participation in the plan, employers will deposit $.50 for every $1 you contribute. That's a risk-free, guaranteed 50 percent return. Failing to capture your full match is akin to turning down a pay raise—you're leaving free money on the table.
An IRA, whether a traditional IRA or Roth IRA, is an entirely different plan. The "I" stands for "individual," which means the program has everything to do with you and nothing to do with your employer. A traditional or conventional IRA works much like a 401(k), absent the employer match. You save taxes today and pay taxes in the future upon withdrawal. A Roth IRA is the exact opposite—no tax savings today but tax-free withdrawals in the future.
Conventional wisdom holds that you should first participate at work in your 401(k) up to the point that you capture the entire employer match, then move on to a Roth IRA. If your employer does not match your contribution, begin instead with a Roth IRA and, after maxing out ($5,000 per year), make contributions to your 401(k). In either case, you're saving for your financial future and doing so smartly and tax-efficiently.