It is never too early to be thinking about retirement. Obviously, if you start early, then the earlier you can retire and the more money you will have working for you. There are a number of ways to save for retirement, but the two most advantageous from a tax stand point are the company sponsored 401k and the government sponsored Roth IRA. So which is better? It depends…
401k: the 401k allows employees of a company to contribute pre-tax dollars to a retirement fund that is invested in mutual funds. When you start drawing from the account at retirement, the money is then taxed as it is taken out. Usually, the way it works is that the company that manages the 401k fund will pick a wide mix of mutual funds for employee’s to pick from. You should ALWAYS contribute to your 401k first if your company matches a percentage of your contribution. The most typical contribution matches are 100%, 50%, and 25%. That means that if your company matches 50% of your contribution then they will GIVE you 50 cents for every dollar that you put into the account. it’s absolutely FREE money!!!! Usually, there are some conditions. At my company, in order for the matched money to be totally vested (in able for you to keep all of the matched money), you have to stay at the company for at least 3 years. Also, there is always a maximum amount of money that can be contributed per year which varies by plan, but it is usually a good chunk of change. The match is always up to a certain percentage of your contribution. My company matches 50% up to 6% of my contributions (up to 3%). Having said that, a matching 401k is always the best way to go. You receive totally free money. Think of it this way, if your company matched 50%, do you think that the tax code in 30 years will be taking half of your money as you withdraw it? I doubt it…that’s why it’s worth it.
Roth IRA: The Roth IRA is another great retirement product. Individuals set these funds up at virtually any financial institution and they are similar to a 401k in that you pick a mix of mutual funds within the fund to invest your money. These accounts were set up by the government, so they do not have anything to do with your employer like the 401k does. The difference is that individuals contribute after-tax dollars into the fund. When individuals start withdrawing from the account at retirement, the money is NOT taxed. This is a beautiful thing! I would ALWAYS recommend to contribute to a Roth IRA before a 401k if your company does not match any of your contributions. I would rather be taxed now on the money I contribute than later. The only down sides to the Roth is that single filers do not qualify to have an IRA if they make more than $110,000 and $160,000 for married joint filers. Also, the most an individual can contribute per IRA is $4,000 per year if you are under 50 years of age.
The bottom line: Do a Roth IRA unless your company matches your 401k.