Last week, we talked about how much of each paycheck we should invest for retirement. Today, we’re going to talk about where we should put that money. Next week, we’ll talk about how to choose investments.
Employer sponsored retirement account (such as a 401k)
If your company offers a 401(k) or 403(b), find out what you need to do to get that full match.
Unless your employer’s 401(k) has crazy-high fees or lousy investment options, you should consider putting enough money into your 401(k) plan to get that full match.
If you are age 50 or younger, you can contribute up to $17,000 to your 401(k) in 2012 (or an extra $5k if you’re older). This limit does not include company match.
If you’d prefer to deal with just one investment account, you can choose to put your entire retirement contributions into your 401(k). But, there are other options to consider first.
Individual Retirement Accounts
If you don’t earn an income but you’re married, did you know you can still contribute to an IRA? As long as one spouse earned income, you can BOTH contribute to an IRA for that year. It’s called a spousal IRA. As long as you’re within the income requirements, if you’re married and under age 50 you can contribute $10k as a household ($5k to each of your IRAs) in 2012. Older than 50? You can contribute an extra $1k per year, per eligible spouse.
If you make a withdrawal from a traditional IRA before age 59.5, you will pay a 10% penalty and income tax. Yuck. There are a few exceptions to this.
Related: Get much more info on IRAs at this CNN Money guide
Not everyone can contribute to a Roth IRA since there are income limits.
Roth IRAs do not receive an upfront tax benefit. It’s taxed just as if you earned $5,000 and put it in a box in your backyard, at least for the year you make the contribution. But then, it grows. Tax-free. Year after year. And when it’s time to withdraw your money, you will not pay taxes on any of it. Amazing!
Further, your direct contributions to a Roth IRA can be withdrawn at any time without penalty (here’s more info on making early withdrawals from traditional and Roth IRAs). Don’t do this unless your circumstances are dire, because you won’t be able to “pay back” your Roth IRA with the balance, and you’ll miss out on future earnings. Still, it’s nice to know our Roth contributions can serve as a catastrophic-event emergency fund.
When you make a contribution to a traditional IRA or traditional 401(k), you are reducing your taxable income for that year (as long as you meet the requirements). So, say you contribute $5,000 to a traditional IRA in 2011. You would reduce your taxable income by $5,000 for that year and will have a smaller income tax burden as a result. Your IRA will continue to grow, tax-deferred, until you start making withdrawals. Those withdrawals will be taxed at your income tax rate at the time.
This calculator at Bankrate can help you determine which is better for your particular situation — a Roth IRA or a traditional IRA?
Where should you open your IRA?
There are a number of investment firms where you can open an IRA. Here are some popular choices:
- Vanguard ($3,000 minimum to open an account, usually — but Target Date funds have a $1,000 minimum!)
- Fidelity ($2,500 minimum to open an account or $200/month)
- T. Rowe Price ($1,000 minimum to open an account)
- Schwab ($1,000 minimum to open an account)
Some banks and credit unions like to advertise their IRAs, but are probably not the best bet.You’ll want to get some more info from them, including the fee schedule and investments available to you. If your only options are in a money market account or CD or other low-interest investment, that’s probably not going to cut it for long-term growth.
Consider the fees
One of the most important things to consider when deciding on where to open your IRA is to understand the fees. Account maintenance fees, transaction fees, the expense ratio, and if there’s a “load” are all ways the investment firm can nickel and dime your investment to bits.
Shane and I are each contributing to Roth IRAs at Vanguard, and Shane is contributing to his traditional 401(k). We chose Roths because we aren’t high-income earners and we like the increased flexibility with accessing our money before retirement, should we need to. Before we had the $3,000 minimum for each account at Vanguard, we stashed the money in a savings account at our bank.
Shane is contributing 6% to his 401(k) to get the full match. He’s not fully vested, which means he needs to stay with his company for four years before 100% of his employer’s contribution are his. If he left the company after 1 year, he’d only get to keep 25% of the employer’s contributions (but all of his). Your company may have different requirements. Shane was fully vested from the get-go at his previous company.
We have our checking account automatically send our IRA contributions to Vanguard. So, 9% of our total retirement contributions are going to our IRAs (4.5% to each). We’d like to increase our IRA contributions until we’re maxing both out.
If we ever reach the point where we’re able to max out both IRAs and still have additional funds to invest, we’ll put the remainder back in the 401(k) until we’re maxing that out, too. That would mean we’d invest $27,000/year for today’s limits! Beyond that, we’ll open a regular taxable brokerage account. I don’t expect we’ll get to that point anytime soon, if ever.
- Decide what percentage of your retirement investments you want to contribute to your company’s 401(k), if applicable. Go to HR and fill out whatever forms are necessary to make that happen.
- Decide where to put the rest of your retirement investments (probably a Roth or traditional IRA).
- Consider various investment firms mentioned above, and research still others to decide which is best for you. Open an account there, or start saving in a regular savings account until you have enough to open an investment account.