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Which Retirement Account to Fund First

Posted by Keith on April 22, 2007 at 12:33 pm  


I have about $500k in investments in four different types of accounts — 401k, IRA, Roth IRA and non retirement Investments. I am looking to retire in about 7 years and am currently saving about $30k per year. My question is: Should I fund my 401k first or my Roth IRA first, or should I pay down my house mortgage to be debt free at retirement?

Regards and best wishes on you adventure.

Richard Wilharm


Sorry for the delay responding. I took a few personal days at home before returning to Hawaii for the next leg of our journey. Here’s what you need to consider:

If your employer is matching any portion of your 401(k) contribution, then contribute at least up to the matched amount first. It is found money and just makes sense.

Second, the general rule is that you want to fund your other tax-deferred accounts before you fund your taxable accounts. However, the higher your tax rate in retirement, the closer you get to retirement, the younger you are when you retire, and as long as tax rates on dividends and capital gains remain low, the more this becomes a close question.

You should really “do the math” on this issue with your financial advisor. There are sophisticated software programs, such as Frontier Analytics (something we used for years at DeGreen Wealth Management) that can calculate to what extent you should fund which account. Again, a good financial planner can help you with this.

Regarding your IRAs, much depends on your age at retirement, and whether you will spend the taxable accounts first. If so, whether you should contribute to your regular or Roth IRA next depends on two things: (a) your tax rate now; and (b) what you believe your tax rate will be upon retirement.

If your tax rate now is substantially higher than it will be in retirement, fund the regular IRA first. Otherwise — especially at your age — go with the Roth.

Caveatt: Before you assume that your tax rate in retirement will be substantially lower than it is now, remember that many people under-estimate their retirement tax liability. So unless you plan on living in a monastary and eating roots, be careful with your estimate.

Regarding whether you should pay off your mortgage, please see my April 12 response to Debra in this column on that very issue. The formula I share there, and the other considerations I discuss in my response, apply to you and to all home owners approaching retirement.

Finally let me emphasize that the best strategy regarding your various accounts is to fill everything you can to the max! Now is the time (Well, actually, 30 years ago would have been better — the money would have had more time to grow — but, hey, 30 years who thought of retirement?) to get very serious about accumulating that retirement savings in all your accounts.

Hope this helps, William. Thanks for your question, and thanks for following The Global Adventure!



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