Should I contribute to my company’s 401(k) or to an IRA?

The 401(k) and the IRA offer tax advantaged savings.  The differences to consider are in maximum contribution limits and matching money.

Employers typically will offer to match a certain portion of your 401(k) contributions to encourage you to invest for you retirement.  The level is most often a percentage of the dollar up to a maximum – i.e., 100% match on the first 5% of your salary that you contribute.  Anything above 5% will not be matched, and anything below 5% will only be matched to the level that you contribute.

In terms of maximum contribution limits, the maximum is much higher for 401(k) plans than for IRAs – $16,500 for 401(k)s in 2011, compared to $5000 for IRAs.

Once you decide how much money you have to invest towards retirement, you should invest in the following order.  Follow this order even if you are not able to invest to all the maximums.

1)    Invest in your 401(k) up to the level of the maximum matching contribution.  This is free money, and you should never leave it on the table.

2)    Maximize your IRA contribution to the annual IRS limit.  You have more control over an IRA than your company’s 401(k).

3)    Go back and maximize your 401(k) contribution to the annual limit, to take advantage of every bit of tax-advantages savings you’ve got.