IRAs have certain advantages, 401(k) have others.

On Monday's edition of Moody Radio's MoneyWise Live, SMI's executive editor Mark Biller talked about how to make the "IRA or 401(k)" decision. And he explained why using both types of accounts (if you have that option) may be the best approach.

If you missed the program, you can listen below. Or scroll down for the transcript.

MoneyWise Live with host Rob West airs daily at 4:00 p.m. ET/3:00 CT. 

For more archived radio appearances by members of the SMI team, visit our Resources page.


Transcript

Rob West:
You can't invest in anything without first making a decision —and some of those decisions are bigger than others.

I'm Rob West. One of the biggest investment decisions you'll make is "IRA or 401(k)?" Or is there a way to have the best of both worlds?

Mark Biller joins us today with some interesting insights on that. Then it's onto your calls at 800-525-7000. This is MoneyWise Live — biblical wisdom for your financial decisions. (theme music ends)

Well, our guest Mark Biller is the executive editor at Sound Mind Investing, where they've been crunching the numbers and comparing the benefits of our two most popular retirement plans — that is, the IRA and the 401(k). Mark, welcome back.

Mark Biller:
Thanks, Rob. Good to be back with you.

Rob West:
Well, Mark, not everyone has a choice between putting their money into a 401(k) or an IRA, but for those that do, they have to make a decision, don't they?

Mark Biller:
They really do, Rob. And you know, IRAs and 401(k)s are similar in a lot of respects. They both offer some really significant tax advantages, which is really what makes figuring this whole topic out worth the effort.

But before we dive into those specifics, there really are a couple of things that we should cover real quickly. First of all, we're assuming in this discussion that a person is "financially ready" to invest. And what we mean by that is that they've got adequate emergency savings set aside. They've got little to no debt — apart from a mortgage and maybe some manageable school loans.

And then the second step is that a person really needs to determine how much they need to be investing each month in order to meet their retirement goals. So in this article that we're discussing today, we link to a free online tool — it's the Fidelity Retirement Score calculator. There are lots of other ones you could use, but that's one that we like. Maybe we can put a link to that in the show notes today?

Rob West:
Absolutely, sure.

Mark Biller:
Well good. So if we've got those two bases covered, then let's just say for the sake of example, somebody runs their numbers and they figure out that they need to be setting aside 10% of their income for retirement. I'm just making up that number. But as a hypothetical, we'll say 10% of their income is being saved for retirement. Now, with that in mind, now they're ready for that big "401(k) or IRA" decision.

Now, obviously, we're assuming here, as well, that somebody has access to a 401(k) plan at work — because if they don't, they don't have a decision, they just go straight down the IRA path.

So the first consideration then is does your employer match a portion of what you would contribute into a 401(k)? And if they do that makes it really easy because that matching money is the easiest profit that you're ever going to get.

So, in a typical setup, an employer might contribute, say, 50 cents for every dollar that you put in — up to a maximum of 6% is kind of typical. Some do a little more, some do a little less. And some employers, if they're really generous, will even match your contributions dollar-for-dollar. So to be clear, then, if you've got a matching option in your 401(k), you're getting an immediate 50% to a 100% percent return on every dollar you contribute! So that's why we say, if you've got a match, you want to contribute to the 401(k) or your workplace retirement plan up to the full amount of the match. Really no questions asked, 'cause that's the easiest money you're ever going to get.

Now, the one thing to watch out for with that is just that some 401(k)s do have vesting requirements, which means you only get the money that your employer matches after you've worked there a certain amount of time. So you just want to be aware of those rules.

Rob West:
So a person who wanted to save 10% of their earnings for retirement, they get 401(k) matching on the first 6%. So they're naturally going to take that free money, which leaves them 4% to decide about. How do they go about making the decision on investing the rest?

Mark Biller:
Yeah. Once we've gotten past that point of matching, then the decision really starts to boil down to how a person plans to invest this money and if the options in their 401(k) plan match up well with how they want to invest it. So I'll give you an example, Rob, to clarify this. If a person really just wants to invest in an S&P 500 index fund, most 401(k) plans are going to offer that option — and they're going to probably offer it at a very low cost. So that person could easily just keep on contributing the additional 4%. In other words, they'd put the full 10% right there in the 401(k). It would keep things very simple and they're done. They're done with this decision.

Now, for our audience at Sound mind Investing, our members typically want to have access to broader investing options than the typical 401(k) plan is going to offer them. So for a lot of our folks, that's where they would want to consider opening up an Individual Retirement Account, or an IRA.

There are a lot of different rules around IRAs and who's eligible for which type. So if you're interested in an IRA, I would really encourage you to look at this article 'cause I think it's easier to see those limits than to hear them over the radio. But generally speaking as a ground-rule, if you're a married couple with earnings of less than about $100,000 per year, you're likely to be eligible for fully deductible contributions to an IRA. As you get up above $100,000, then you're going to have to look at those specific cutoffs.

Rob West:
When does a Roth IRA come into play and how should we consider that?

Mark Biller:
Yeah, Roths are great for certain circumstances, especially. Now the contribution rules around a Roth are a little different than the traditional IRA that we were talking about a moment ago. So with a traditional IRA, when you put money into the IRA, you get an immediate tax benefit. And that can be great, especially for folks if they're maybe towards the later part of their career and their income is higher, that tax break right away is more valuable.

But generally speaking — and it's not just for younger folks, I don't want to misapply this — but certainly, for younger workers who are at the lower end of their earning arc for their career, the Roth IRA can be amazing because with a Roth, you don't get an immediate tax benefit when you put the money into the Roth IRA but what you do get is at the end at the retirement and when you're taking money out of the Roth, none of that money is taxed when you take that out.

So with a traditional IRA, you get a tax benefit now but you pay taxes later. With a Roth IRA, no tax benefit now, but no taxes later. So that could be an amazing deal.

Now, as far as our conversation today, those contribution limits for a Roth are more lenient. So whereas we said some of those cutoffs and phase-outs started about $100,000 of income for a couple for a traditional IRA, it's closer to $200,000 for a Roth IRA. So a lot more people are going to be eligible over there. And so if you are eligible for either of these types of IRAs, and most people are then as I was saying earlier, Rob, at SMI, we typically lean towards using the IRA for that additional contribution money because it's so much more flexible in terms of what you can invest in.

Now, I would say there is one little caveat, and that is some people in their 401(k) plan, they're offered something called a "brokerage window." And that can be a great option because it allows you to stick with the 401(k) and keep things simple that way, but that brokerage window opens up the full range of investment options, just like an IRA would. So that's something that's worth checking on: If you have a 401(k), does it offer a brokerage window? Because if it does, there may be very little reason to need to go out beyond the 401(k) and open up an IRA.

Rob West:
Mark, do you like the idea of having the tax-deferred and the tax-free buckets to choose from in retirement? Let's say that's 20 or 30 years down the road. We don't know what the tax code is going to look like. We don't know what our income is going to look like. So does having the choice between money that is pre-tax versus, you know, already [taxed and] going to come out tax-free, does that give you any advantage at that point?

Mark Biller:
I think that it does. I've always been a fan of that "tax diversification." That's kind of the label that I've always put on that. And that's how I have approached things myself. So I have a blend of both of those IRA types within my portfolio. Now, I would say that again for a younger person, I really wouldn't worry about that too much. Because to my eye, and of course, this is a broad brush, but really that tax advantage to the traditional becomes much more valuable as your income rises. So I would pack the Roth early and maybe do the traditional later on.

Rob West:
I like that. If time is on your side, that Roth IRA, maybe just the ticket —we can thank Sen. William Roth for that.

All right. When we come back, Mark's going to stay with us and we're just going to dive into your questions. Earnest and Darrell and Fred are all waiting patiently. We'll be back with you in just a moment.

This is MoneyWise Live. Mark Biller from Sound Mind Investing here. Much more to come just around the corner.


Rob West:
Grateful to have you along with us today on MoneyWise Live. I'm Rob West. Joining me today, Mark Biller, executive editor at Sound Mind Investing. You can learn more at soundmindinvesting.org.

Let's head to the phones with your investing-related questions. Naples, Florida — hi, Ernest. How can I help you, sir?

Caller:
Hello, sir. How you doing? Real quick. I just like to ask Mark a question and about the 401(k).

I've currently been on my job for about 10 years, Mark, and I didn't invest when I first started, because my job does offer a 401. I'm a little late starting, but I just don't know how to go about starting it. I was wondering if you could help me.

Mark Biller:
Yeah, absolutely.

Rob West:
Ernest, just a quick question. Tell us a little bit about the rest of your financial life. I understand here from the notes from my producer, you might have a little bit of credit card debt and that you're trying to down. So give us a sense of that picture.

Caller:
Yeah, I was completely debt-free and I had some dental work done and it ran — I charged it because I didn't have any bills. I was debt-free. But it's six grand, it's currently five grand. But I should have that paid off in about six months. That's my only bills other than my, you know, the rest of my bills as far as cable, electric, and all that kind of stuff

Rob West:
Sure. And do you have an emergency fund, Earnest, with a reserve?

Caller:
About 15 grand.

Rob West:
15,000. Okay. Have you thought about — how much do you have in margin each month over and above your bills?

Caller:
I bring in about 45[-hundred] a month, so I'm free to really, you know, aggressively — that's why the credit card won't be, it won't be out there too long because I had no other major bills other than that, of my, you know, regular daily bills.

Rob West:
Yes. Well, if you've demonstrated that you have that kind of margin consistently on a monthly basis, one option would be to go ahead and wipe out that credit card debt with the emergency fund. And then just build that back up over the next six months to that $15,000 target. But beyond that, Mark, what thoughts do you have on getting started in the 401(k)?

Mark Biller:
Yeah, I really liked that idea of knocking out that credit card debt right away, because there's probably a pretty high interest rate attached to that. So I'd hate to be putting money into the 401(k) and maybe making less there than we're actually paying in that credit card interest. So let's go ahead and try and get rid of that right away.

Earnest, how old are you?

Caller:
I'm 54.

Mark Biller:
Okay, very good. So, Earnest, I definitely would encourage you to investigate the 401(k) and see what kind of matching if any is available. Usually, you can get that set up with your company's HR department pretty easily, and they may have some default contribution options.

A lot of plans will offer what's called a targeted, a target fund where you pick the year that you anticipate you're going to retire in. So for you, you might be looking at a "2030" or a "2035" type fund. And what that fund will do for you is actually invest between stocks and bonds automatically in the proportion that is is roughly what that fund company considers to be right for a person your age. And that mix between stocks and bonds will get gradually more conservative as you approach that retirement year that you choose.

And that can be a really nice initial option at least, as you're just kind of trying to figure out exactly how you want to invest that. Some people are going to just stick with that and just let that ride all the way through retirement. There's nothing wrong with that. That'll be a good blend of stocks and bonds for you. Or, if you're more inclined to want to tinker with that a little bit, that'll buy you a little bit of time to figure out the exact asset mix between stocks and bonds — maybe look over whatever other options are available in the plan and see if there's anything you want to do differently there. But that would hopefully get you started.

And again, the same things we were talking about earlier, figuring out how much does your employer match, trying to get up to that percentage at least as quickly as possible, and then figuring out if you can add additionally from there. Rob, any other thoughts?

Rob West:
No, once you pay off that credit card debt, the only other thing I would say, Ernest, is because you're starting a little later, let's set a target of maybe at least 15%, if you can do it, of your pay going into a retirement account. And you still got time on your side. Just get started as quick as you can. And we appreciate your call.

Darrell is in Fort Wayne, Indiana. Darrell, how can Mark and I help you today?

Caller:
Yeah, I just had a question about savings accounts and money markets accounts. I have an emergency fund and some extra that I was wondering what to do with. The rate at the bank is, you know, 0.01%, maybe .15 on a good day — if you meet certain criteria. But I just wonder if there's a better way to save that money and to get some kind of interest out of it other than that small amount.

Rob West:
And let me just make sure I'm clear. This is specifically for your emergency fund or is this for funds beyond your emergency fund?

Caller:
It'd be beyond.

Rob West:
Okay. And what would be the time horizon on this money? Is this money you wouldn't want to touch for five years or more?

Caller:
Possibly. Yeah.

Rob West:
Okay. And you're talking about savings accounts and so are you wanting to not take any risks with this money? I mean, are you willing to invest it in stocks and bonds or do you want to keep it more on the conservative end? Even potentially the guaranteed end?

Caller:
Probably a little more conservative. But I just wasn't sure if index funds, or is it money market funds, would be a good option. Yeah.

Rob West:
And how much money are we talking about

Caller:
Maybe $10,000 or $20,000.

Rob West:
Okay. So, Mark, $10,000 or $20,000. This is money beyond the emergency fund. Wanting to stay on the more conservative end of the risk spectrum, but not happy with a savings interest — which I can certainly understand. What are your thoughts?

Mark Biller:
It is tricky. There are not a lot of very good conservative saving and investing options. It's a real problem right now for a lot of retirees, a lot of savers. There is really only one bright spot on that landscape right now that comes to mind as I hear the things you're trying to accomplish.

Right now, Series I Savings Bonds — the I is for inflation — these particular flavor of U.S, Treasury Savings Bonds, the I-Bonds, are actually yielding a pretty attractive rate. There is 7.1% right now. There are some limitations and you have to buy those directly from the Treasury. So you have to set up an online account. It's not particularly difficult to do that. You fund it directly through your bank account. And you have to hold those at least a year. So there are some restrictions around these, but they are pretty liquid. You can have access to the money in a year. They're very safe. They're Treasury bonds and they're yielding a lot more than most other bond types.

I'd love to point you to an article. We actually have an article coming out on these in our December issue of Sound Mind Investing, which is going to hit our website next week — in the middle of next week. So I'm not trying to tease you there. I've just been writing about them recently. I know that they're about the only lone bright spot on the bond landscape at the moment. You can certainly look those up on the government's TreasuryDirect website, if you want to do that, to get more information sooner. But that might be a good option for you to look at, Darrell.

Any other thoughts, Rob?

Rob West:
No, I think that's exactly right. And what does the max you can put in a calendar year for those I-Bonds, Mark?

Mark Biller:
Yeah, they're limited to $10,000, but that is per calendar year. So you could potentially get an account set up and get $10,000 in right now, and then turn right around at the beginning of 2022 and put more in, if you were trying to get a little bit more in.

Rob West:
I think that's tailor-made for you given the amount of money we're talking about the yield that you'll find with those right now. And you know, the safety that you're looking for. Again, TreasuryDirect.gov — and if you want to read more soundmindinvesting.org.

We're going to finish today with Fred in Wheeling. I'm going to voice his question because we're short on time here, Mark. He and his wife have 401(k)s under each of their names with their respective employers. They're retiring next year and wanting to know, should we combine these? I know you can't do that, but talk to them about this decision — whether or not to roll it out to an IRA and whether they should stay with their current management companies or consider a change.

Mark Biller:
Yeah, good questions. So this kind of gets back to what we were talking about earlier, Rob, where if you are happy with the investment options that you have in your 401(k) and the expenses seem reasonable within the 401(k), then there really isn't a need to make that move.

If, on the other hand, there are some other things you would like to be doing investment-wise with that money, that's where rolling that out to an IRA can be particularly attractive. And in a case where you've got two different 401(k) is it doesn't necessarily have to be an all-or-none decision. You could consider rolling one of those to an IRA and keeping the other one if you like those investment choices. So you've got some flexibility there. That would be my approach — would be to look very closely at how do I want to invest and how do these options match up with that?

Rob West:
Good. And, Mark, as we finish here — just got a few seconds left — y'know, this is not just about, when we talk about retirement, accumulating absolutely as much as possible. We need to set a "financial finish line," which is also going to be a tool to tell us when we can accelerate our giving, right?

Mark Biller:
Oh, absolutely. This isn't about accumulating the biggest pile you can. It's about meeting your needs and honoring God with the rest.

Rob West:
Awesome. Well, Mark, thank you for sticking around a little extra today. We had lots of questions and so I appreciate you fielding those. Grateful for you, my friend.

Mark Biller:
 Thank you, Rob. My pleasure

Rob West:
Mark Biller has been our guest today is executive editor at Sound Mind Investing. You can find out more soundmindinvesting.org. Thanks for being here.

MoneyWise Live is a partnership between Moody Radio and MoneyWise Media. Thank you to Dan, Melody, Amy, and Robert. Couldn't do it without 'em. Come back and join us tomorrow, will you? God bless you. Bye-bye!