Do this before maxing out your 401(k)
Depending on how much you need to save for retirement, your income and a variety of other factors, you may want to fund other accounts before depositing the full $18,000 in your 401(k).
Freshly-cut stacks of $100 bills make their way down the line at the Bureau of Engraving and Printing Western Currency Facility in Fort Worth, Texas (Sept. 24, 2013). Depending on how much you need to save for retirement, your income and a variety of other factors, you may want to fund other accounts before maxing out your 401(k).
LM Otero/AP/File
鈥淪hould I max out my 401(k)?鈥� This question is often answered quickly, with a simple, 鈥淵es! Defer taxes for as long as you can.鈥�
However, depending on , your income and a variety of other factors, you may want to fund other accounts before depositing the 聽in your 401(k).
To help answer the question, here are聽two 鈥済ivens鈥� that are true for everybody:
Given #1: Fill up your emergency fund first
Before even thinking about retirement savings, pad聽your . I recommend having at least six months of living expenses set aside in a separate聽bank account for times when life throws you the inevitable financial curveball.
Given #2: Grab the company match second
Once you鈥檙e set for emergencies,聽make sure you鈥檙e contributing at least as much to your 401(k) as your company is willing to give you in matching contributions. For example, if your employer matches聽up to 6% of your salary, put away聽at least the full 6%. That match is free money!
After that, things get more complicated. Ask yourself these questions to decide聽how much additional money you should contribute to your 401(k) 鈥� and how much you should contribute to other accounts:
How much do I need for retirement?
In general, the earlier you get started, the less you need to save for retirement. Let鈥檚 say you鈥檙e in your 20s and have determined you need to save 12% every year to meet your retirement goals. If your company matches 6%, you can contribute 6%, score聽the 6% match, and might not need to make any further contributions.聽You can put extra money聽toward a down payment聽on a house or your kids鈥� college tuition.
Or perhaps you鈥檙e getting started in your late 30s and have determined that you need to save 21% of your income toward retirement to meet your goals. If your employer matches 3% of your salary and you make $100,000 a year, you could save enough by making the maximum 401(k) contribution and receiving聽the 3% match.
But after you鈥檝e snagged the free money your employer offers, there are also good reasons direct some of your retirement savings toward聽a 聽鈥� whether or not you need to make additional contributions. Unlike 401(k) contributions, Roth IRA contributions are post-tax. They聽then grow tax-free, along with their earnings, and you won鈥檛 pay additional taxes on them when you . Their features can benefit savers for three reasons:
1) Having your savings split between聽tax-deferred and聽tax-free accounts gives you maximum 鈥渢ax flexibility鈥� in聽retirement. There鈥檚 no single right answer for everyone, but聽as a general rule, consider having 60%聽to聽80% of your savings in tax-deferred accounts, such as your 401(k), and 20%聽to聽40% in tax-free accounts, such as聽a Roth IRA.
2)聽Many 401(k) plans have limited investment choices and high fees. But if you have a Roth IRA, you can either invest it yourself or work with a financial advisor to construct a well-diversified portfolio of . Roth IRAs give you more control over your investments and their costs, letting聽more of your hard-earned money grow on your behalf in your account.
3) Roths are an especially good idea if you鈥檙e in a relatively low tax bracket now. It probably makes sense for you to pay taxes in this lower bracket by , rather than saving all of your money in your tax-deferred 401(k), only to end up paying at a higher rate in retirement.
Now, one final question before you make a call on how much to tuck away into that 401(k):
How much money do you make?
If you鈥檙e single with a modified adjusted gross income in excess of $132,000 or married with a MAGI of more than $194,000, you鈥檙e not allowed to contribute to a Roth IRA. In this instance, it probably does make sense to max out your 401(k).
If you鈥檙e still looking to shield additional income from taxes, you can consider investment real estate and certain life insurance products, but we鈥檒l leave that discussion for another day.
Good luck working your way through your decision on how much to contribute to your 401(k) and with all of your retirement and savings goals!
is a certified financial planner and the founder of . This article first appeared at .