Choosing where to put your retirement money can be confusing.
Everyone knows that they’re supposed to invest for retirement. Some actually do and some don’t. But a common question that both current and prospective investors ask is: if I have a limited amount to contribute to my retirement, where should I put my money first, second and so on?
This is a guide to help you answer that question and figure out the best place to put your money for retirement investments. The answer is not the same for everyone.
In a best-case scenario, you’d max out your legally allowed retirement contributions each year. But many of us are not in a best-case scenario. We need to prioritize and place our money where it will be most effective. Here are some rules to guide in prioritizing your retirement investments. They are followed by a step by step decision making process:
Retirement Rule #1: Maximize Your Employer’s Matching Contribution
If your employer provides matching contributions in a company sponsored plan, then put in as much as you need to receive the FULL match. Don’t invest or save a dollar anywhere else until you’ve taken advantage of this immediate return. It’s not everyday that you can get 25-100% of a return on your investment in the matter of a day. That’s effectively what’s happening here.
Rule #1 was the easy part. But if your company doesn’t match, or you’ve got some left over money to invest, how do you choose between the other options?
Retirement Rule #2: Prefer Quality and Flexibility
If your employer’s retirement plan is very restrictive and doesn’t offer you very many good investment options, then opt to first max-out your self-selected IRA. Choosing a good IRA is as easy as choosing a good mutual fund: you want to identify a fund that has a strong track record, low-fees, good management and is poised to provide consistently high, long-term returns.
On the other hand, if you’re company’s plan does offer a wide array of good investments, it may also offer some “flexibility perks” that an IRA cannot offer. Many employer sponsored plans allow you to have non-penalized access to your funds via self-given loans that you might want access to in emergencies. While we strongly advise against touching your retirement funds, at least the money is available. On the other hand, if you can’t resist the temptation of using your retirement funds for non-emergency expenses, it may be advisable to stay with the IRA!
Retirement Rule #3: Roth or Traditional IRA?
In 2006, each individual can contribute $4000 to an IRA account. Individuals over the age of 50 can contribute $5000. But there are two IRA options: Traditional and Roth. Which should you pick? As a general rule, choose Roth if you plan to be in a higher tax bracket when you retire and choose Traditional if you think you’ll be in a lower tax bracket when you retire. The reason: you minimize the taxes you have to pay.
Questions to help you make your decision
1. Do you have enough money to maximize all your retirement options?
- If yes, then do it! Just make sure to make wise investment decisions
- If not, then proceed to question 2
2. Does your employer offer matching contributions?
- If yes, then make sure you receive every bit of this match. Stretch yourself if needs be. But always make sure that you select a good investment from the options that are avaible.
- If not, then things get a bit more subjective. Move to question 3.
3. Is your employer plan overly restrictive, offering only poor investment choices?
- If yes, then opt for an IRA choosing the one that minimizes your tax payments
- If not, then move to question 4
4. Choose the investment vehicle that offers the best long-term management of your money.