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Contributing to your 401(k) or your IRA

Posted by Andrew Chan  May 13, 2010 11:00 AM

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I have a 401(k) from work which my employer matches 50 percent. It has about $68,000 in it as of today and I contribute 17 percent, bi-weekly. I also have an IRA which I pay a quarterly fee to have managed and the return is about 13 percent. However, I do not contribute new money to my IRA. I'm wondering if I should contribute to both accounts simultaneously.

Based on the information in your question, I would generally recommend that you contribute to both, your 401(k) and your IRA if you are able to afford it from a cash flow perspective. It is difficult to do a side-by-side comparison of your two accounts, however I would suggest that you continue to fund your 401(k) first. At a minimum, you should fund your 401(k) enough to receive the full amount of your employer's matching contribution. Your employer's matching contribution is effectively free money which you should not pass up if you can afford to make your contribution.

After funding your 401(k) enough to receive your employer's matching contribution, I would evaluate the advantages and disadvantages of contributing more money to your 401(k) or to your IRA account. Some of the key factors to evaluate are:

1) Investment options - Evaluate which account offers you the best selection of investment choices to help you create a diversified portfolio within that account and/or across all of your investments. This includes evaluating the quality and performance of those investment options. Keep in mind that an account with a higher number of investment choices is not necessarily better than one with fewer choices if the investment options offered are not as good.

2) Costs - Evaluate the cost to invest in the options available in each account as well as the costs to maintain the account. This includes transaction fees, commissions, advisory fees, mutual fund expenses, etc.

3) Tax benefits - Evaluate your current tax situation in the context of contributing to each type of account. For example, contributions to an IRA may be tax deductible, if you qualify, but contributions to your 401(k) may reduce your taxable income.

4) Investment Risks - Evaluate the risks associated with each investment offered relative to your own risk profile.
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