How to Prioritize 401(k) and IRA Contributions

Create an investment plan that best utilizes both types of retirement accounts.

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Many full-time employees have the ability to contribute to a 401(k) plan and an IRA. It's not always easy to decide how to divide your contributions between these two accounts. Instead of picking a random percentage, take a look at the benefits of each account and create an investment plan that best utilizes both types of retirement accounts.

[Bookmark the U.S. News Retirement site for more planning ideas and advice.]

The best way for most people to maximize their retirement savings is to contribute enough to a 401(k) plan to get the maximum employer match. Next, max out an IRA. After that, work toward maxing out the 401(k). Here’s a look at how to best utilize a 401(k) and IRA on a limited budget.

Start with your 401(k) plan if you get an employer match. If your employer offers a 401(k) match, do your best to contribute enough to get the full employer match. If you don't have an employer match, consider maxing out an IRA before saving in the 401(k) plan.

Why choose an IRA over a 401(k) plan? Many 401(k) plans have more limited investment options and higher investment fees than you can find with an IRA. You can open an IRA at virtually any financial institution and have access to a wide variety of investment options. This gives you the ability to more easily choose your investments and control your investment costs than you can with a 401(k) plan.

[See 6 Ways to Catch Up on Retirement Savings.]

After you max out your IRA, then save more in your 401(k). The biggest down side of an IRA is the lower contribution limit. Retirement savers can only defer taxes on up to $5,000 in 2010, or $6,000 if they are age 50 or over. Employees can contribute up to $16,500 to a 401(k) this year, a limit that jumps to $22,000 after age 50. Once you max out your IRA, then you should contribute more to the 401(k) plan in order to defer taxes on more of your savings until retirement.

Determine your contributions the easy way. You should be able to figure out how much to save in each type of retirement account in a few minutes. If you have an employer match, determine how much you need to save to get the full employer contribution. If you have room left over in your budget, then figure out how much you can contribute to an IRA. Those under age 50 can max out an IRA with a monthly contribution of $416.66. If you have additional income that could potentially be tucked away for retirement, contribute more to your 401(k) each month.

What if you can't max out either account? If you don’t earn enough to save in both a 401(k) and IRA, choose the option that gives you the best financial benefits. Go for the 401(k) if you receive an employer match or an IRA if you don't receive a matching contribution. If you are able to max out both accounts, then you are well on your way to a great retirement. If you still want to further invest for your future, then consider investing in a taxable investment account. There are dozens of great online discount brokerages that offer low cost trades and features to help you choose the best investments for your needs and risk tolerance.

[See The 100 Best Mutual Funds for the Long Term.]

To recap: Invest enough in your 401(k) to max out your employer contributions. Next, max out your IRA. Then, work toward maxing out your 401(k). If you have additional funds you can invest toward retirement, then invest in a taxable investment fund.

Ryan Guina is a U.S. military veteran, writer, and professional in the corporate world. He blogs at Cash Money Life and The Military Wallet.