Ask The Money Coach

Q: I am a 27-Year-old Speech-Language Pathologist and I Currently Do Contract Work for a School System. Even Though I Am Not Sure If I Will Be With My Company Next year, Should I take Advantage of Their 401(k) or Open an IRA or Roth IRA?

A: By all means, start contributing to your company’s 401(k) plan immediately. Even if you leave the company or take another job elsewhere, you will have access to your 401(k) funds and can transfer them later – if you decide to – into an IRA. There are six big benefits to taking advantage of your 401(k) plan right now.

Lower Your Tax Bill
First, you will immediately lower your taxable income and start paying fewer income taxes to Uncle Sam. This is because you contribute to a 401(k) plan right out of your paycheck, on a pre-tax basis. By contrast, you fund an IRA with after-tax dollars. Your ability to take an IRA tax deduction is based on several factors, including your income.

Matching Contributions
Additionally, you may get additional retirement dollars from your employer, if your company offers any kind of matching program. Some companies match dollar-for-dollar, up to a certain percentage of your salary. Others offer 50 cents on the dollar. No matter how much or how little your company match might be, it’s still a great benefit, because it’s free money.

Flexibility
Thirdly, since you are a contract worker, you may be better off initially using a 401(k) plan, instead of an IRA, because the 401(k) generally offers you more flexibility and options to access monies without penalty. For example, you can take a loan from your 401(k) if necessary. But you generally can’t take loans from IRAs. You can take distributions from IRAs, but if they aren’t paid back within 60 days, the IRS imposes a 10% penalty, and you pay ordinary income taxes on the money too.

Higher Contribution Limits
401(k) plans have higher contribution limits than do Individual Retirement Accounts. Under federal law, the maximum amount you can put into a 401(k) in 2010 is $16,500; individuals age 50 and older can stash away an extra $5,500 in a 401(k). The limit is subject to cost-of living increase after 2010. The maximum you can put into an IRA in 2010 (either a regular IRA or a Roth IRA) is $5,000; those 50 and older can contribute an additional $1,000 into an IRA. The ability to sock away substantially more money is a 401(k) is a huge benefit that should be taken advantage of whenever possible.

Disciplined Investing
Making investments through your 401(k) plan is a great way to make you consistent and dedicated to the process of investing. Because the money is taken automatically out of your paycheck, you might not think about it as much and you won’t be as tempted to just stop investing when the markets get volatile. All too often, when people put their money into Individual Retirement Accounts, at the first sign of trouble on Wall Street, they simply stop investing. That’s not a good way to invest.

Ease of Implementation
As a final note, there’s also the speed of execution factor, which shouldn’t be ignored. You can literally go enroll in that 401(k) plan today. Just pop over into your Human Resources office and fill out some brief paperwork. You’d have to do quite a bit more homework and paperwork to open an IRA. Sometimes, when things take too long and seem like to much work, we tend to procrastinate and not get them done. That won’t be the case with your 401(k).

You stated that you’ve already been working at your company for more than a year. So now is a great time to get into the habit of saving early and often for retirement. The 401(k) plan offered by your employer will help you do just that.

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