Imagine that you’re starting a new job. Your new employer offers a 401(k) plan. Each month, they’ll take funds from your gross salary and place them in the company’s 401(k). That lowers your taxes. In addition, if you want to contribute up to $1,000 to your 401(k) yourself each year, the company will match your contribution. Those funds will take time to vest. But as long as you’re still working there in three years, you’ll have added $1,000 to your salary each year and lowered your tax liability even further.
Once you’ve maxed out the benefits available from your 401(k), you can turn to your IRA. Add as much as you can, and again you’ll be able to lower your taxes while saving for the future.
If your income rises, you might find that it pays to continue maxing out payments to your 401(k) but ease up on your IRA contributions. The combination of a high income and a workplace retirement account will reduce the value of your deductions and might make other forms of investment more attractive.
Some experts suggest that if your company doesn’t offer matching funds, it’s worth skipping the 401(k)—or at least the extra contributions—and heading first to the IRA. As long as you’re not earning enough to reduce the value of your deduction, you’ll get the benefit of being able to choose your own retirement fund. There’s also a good chance that you’ll be able to save on administration fees.
Once you’ve wrung all the benefits you can out of that IRA then, say the advisors, you should turn to your company’s 401(k).
In general though, unless the workplace 401(k) is particularly poor, offers no matching funds, and has high fees, experts advise employees to make the most of it.
So 401(k) plans and IRAs can work together. Fill one, usually the 401(k), then use the other to contribute more to your retirement and reduce your taxes further.