One of the questions that many people have as they plan for retirement is whether they should fund a 401k or an IRA first. And, of course, the answer depends on what you are trying to accomplish with your retirement fund.

IRAs and 401ks have some different advantages and disadvantages, and it is up to you to determine what is most likely to be the best course of action for you. As you try to figure out what to do with your retirement money, here are some things to consider:

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One of the oft-discussed cardinal sins in personal finance is to borrow from your 401(k), 403(b), or other eligible retirement accounts. The reasons against borrowing are obvious – those assets are for you to consume in retirement, not right now. By borrowing those funds, they can’t grow with the market tax free and you lose one of the great vehicles for retirement planning.

Not everyone can borrow from their 401(k) or 403(b), the plan administrator has to permit it, but this Devil’s Advocate post will discuss reasons why this may make sense for the limited number of employees who can borrow from their 401(k) plan.

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Every year around this time the IRS releases updated retirement contribution and tax bracket information for the coming year. We probably won’t see much by way of tax bracket information since Congress has its work cut out for it, but earlier this month they released contribution and deduction limits for retirement account contributions for 2011. As you’d expect, not much changed since inflation was minimal.

There were no changes to the contribution limits and some phaseouts saw their ranges increase slightly.

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A few years ago, when the economy was great, most of the people who didn’t save for retirement usually didn’t think about it. It’s difficult to think of the far future on a regular day, it’s even tougher to think about it when it’s sunny, beautiful, and there isn’t a cloud in the sky. It’s toughest when the economy is rough, we’re all playing defense, and it doesn’t seem like we’ll even make it to tomorrow, let alone the next twenty or thirty years. It is, however, always important to think about saving for retirement and fortunately it’s not as expensive as you may think. You can afford to save for retirement, it will cost you very little, and I will explain why.

When you make contributions to an employer 401(k), you get an immediate tax deduction if it’s withdrawn from your paycheck. We’ll look at more examples below but if you contribute $100 a pay period and are in the 28% tax bracket, only $72 is deducted from your paycheck (you contribute $100 but get the deduction, so you pay $28 less in taxes). If your company offers a 401(k) and a company match, saving for retirement is even cheaper.

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After writing this morning’s Betterment review and reading about their rebalancing feature, I started thinking about rebalancing. Betterment rebalances your portfolio after each quarter and if your actuals deviate from your allocation by more than 5%. In other words, they rebalance on a schedule and when the deviation exceeds a certain level (5%). When you read about rebalancing and when you should do it, many places often just point to a calendar date – rebalance every quarter, every six months, or once a year.

What is Rebalancing?

Rebalancing is the act of adjusting your actual investment allocation so that it meets you desired investment allocation. If you want to be 80% stocks and 20% bonds, you need to rebalance your investments periodically since both will likely perform differently over time. How often and when you rebalance is a matter of debate but as is the case with any type of investing (or gambling), it’s about the odds, your plan, and sticking with the plan as long as it’s worth sticking to!

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You’ve probably heard that your most valuable asset is time. For new graduates, that line actually refers to two different ideas, both of which are critically important to understand. The first idea is that with few entanglements and draws on your time (mainly no kids), you can devote more of it to your career and engineer the largest advancements in your career.

The second refers to the power of compounding interest and that’s important to understand with regards to your retirement in forty+ years.
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Are you a highly compensated employee? No matter what you make, you probably don’t feel like a highly compensated employee (what’s that old saying – happiness is making a dollar more than you’re wife’s sister’s husband? ), but you might just be one. Whether or not you’re a highly compensated employee has an impact on your employer’s retirement benefits package. The retirement program has to prove that there is no bias towards highly compensated employees or it could lose the tax breaks it gets for having a retirement package.

A highly compensated employee is someone who owns more than a 5% interest in your business at any time during the year. Or, they could be considered highly compensated if they, in the preceding year, received compensation in excess of a specified amount (see the list below) and, if you choose to add this criteria, be in the top 20% of employees when ranked by compensation.

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When I started working after college, it was a bit of a stretch to contribute to both my 401(k), to get my employer match, fully fund my Roth IRA, and build up a small cash cushion (I would later learn these are called emergency funds). I pushed to do it because my parents drilled this lesson into my brain as a young adult – save money today because you never know what will happen tomorrow. (I thought I dodged a bullet by avoiding the dot com boom and bust but I was later rewarded for my diligence with the largest recession since the Great Depression!)

So… what do I do with the money in my Roth IRA or my 401(k)? You will never be able to predict the future with certainty so you will never know beforehand which investments will perform the best. You will, however, know the cost of owning those investments and the cost of taxes if you pick correctly. The best we can do is have a good plan, execute that plan, and pick investments that provide the most value for the price that you pay in fees and taxes.

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