Expert: Paul Henneman - 6/9/2007

Question
Hi Paul,

I'm currently enrolled in a 401k plan at work (but I'm not contributing at the highest % allowable).  I also want to make some investments beside that 401k. I read about IRA's and other brokerage account types.  But the more I read the more I am confused about the direction to take.  I don't know if I should contribute more to my 401k, open an IRA, or open an IRA & at the same time a regular brokerage account (IRA because of its tax advantage, regular brokerage because the fund is not limited to $4000 or whatever it is for the calendar year).  Can you give me an advice?

Thanks

Answer
Xung,
  Thank you for your question!
Unfortunately the answers the questions you have are different for every investor. I can perhaps provide some information regarding the different types of accounts that you mention, but every investor will make different decisions on what to do based on their specific needs.
  First, I am assuming that you do not need access to these funds that you plan to invest until you retire (age 59 1/2 or later).  If you do want to be able to access your investments before then, the retirement accounts carry tax and other penalities whereas the individual account at a brokerage firm does not.
   If you are investing for the long term until you retire, then the tax advantages of a retirment plan cannot be ignored. Lets start with a 401K.  This is a great retirmenet plan, one where you are contributing 'pre tax' dollars, meaning that you do not pay income tax on your contributions. This is a big deal.  However, every 401k plan is different regarding the investments that you can purchase through your plan. Some are good, others not so good. Hopefully your plan has some good investments to offer, if so a 401k is easy to invest automatically into each pay period, and avoid income tax on that amount.
   IRA's are also good, but a few things that make them different than 401k's. First, you are investing money after you have paid income tax. Big difference. If you do not qualify for a retirement plan through work then you can deduct your IRA contributions at the end of the year, but this clearly does not apply to you.
   However, IRA's still have the benefit that you do not need to pay tax on the returns each year. This is a big tax advantage over an individual account at a brokerage firm.  I see that you are aware that your contriubtions are limited to $4,000/year, that goes up to $5,000/year next year.
   It would be very difficult to ignore the tax advantages that a 401k and IRA both offer. You could invest up to 15% of your salary in the 401k, plus another $4,000/year into the IRA. Anything above that would need to be invested into some other type of investment, such as a stock portfolio or mutual funds through an individual account at a major brokerage firm.
   I do strongly recommend that you pick up a copy of "Investing for Dummies". While this is not a very flattering title, the book does a good job of going through each type of investment. You will get an understanding of the specific tax advantages of each option, and hopefully come up with a plan that works best for you.

I hope this helps! Please do not hesitate to follow up with me if I can be of any further service, and best of luck!

Sincerely,
Paul Henneman
President
ValuEngine Inc
www.ValuEngine.com