Max out my Roth IRA or diversify first?
May 31, 2010 9:40 AM   Subscribe

Should I max out the contribution to my Roth IRA before beginning to diversify?

I am new to retirement planning (age 30) and am currently putting approximately $2,000 a year into my Roth IRA. I also put $1,200 back a year into a savings account for emergencies.

However, I am getting a raise this coming year and will have more money to invest. Is the best strategy to "max" out my Roth IRA (I think the current maximum is $5,000) contribution or to start investing in other things while not putting in the max to my IRA?

I appreciate any helpful advice you can offer.

posted by bengalsfan1 to Work & Money (14 answers total) 1 user marked this as a favorite
An IRA (Roth or otherwise) is really just an "umbrella" that you put retirement savings under. Once under this umbrella, you are free to invest in just about anything you want - splitting the total balance among as many investments as you choose.

I use Fidelity and I have a US market index fund, a few regional international mutual funds, a few stocks, and a couple sector funds.

I suggest you call the holder of your Roth IRA (Fidelity, Vanguard, whomever..) and ask them about your options. Also, it is highly worth your while to pick up a basic investing book - I suggest The Bogleheads' Guide to Investing.
posted by mbatch at 9:47 AM on May 31, 2010

Best answer: Think of an IRA as a specially-marked envelope. On the envelope is written "My retirement money" and you've promised to only use the money in that envelope for your retirement.

You can put up to $5000 worth of stuff in that envelope every year, and have a tax advantage to do so. The stuff can be mutual funds, stocks, bonds, CDs. So, if last year you put $2000-worth of the S&P 500 mutual fund in the envelope, this year you can do the same but with something else... other index funds like the S&P 500, stocks, CDs. In other words, you can diversify while putting money in your IRA -- it's not an either/or situation.
posted by Houstonian at 10:05 AM on May 31, 2010

(And yes, you should max out your IRA. Pick many different things to put in that envelope, but put in the maximum allowed or as much as you can.)
posted by Houstonian at 10:07 AM on May 31, 2010

You should always max out your IRA when you get the chance. The benefits of saving (and investing) more at a younger age are much much higher than doing so later on. You get those additional years to grow your savings, and it can make all the difference later on.
posted by msbutah at 10:29 AM on May 31, 2010

You aren't saving enough. Yes, max out the IRA.
posted by ferdinand.bardamu at 10:59 AM on May 31, 2010

Agreeing with everyone who has answered so far, but I do have something to add: Do you have a 401(k) at work? Do they provide any matching funds?

If so, the basic advice is usually to fund your 401(k) so you get the maximum amount of matching funds they offer (it's like getting 100% interest, and what investment is going to come close to that?), THEN max out your Roth IRA (because it offers the best tax advantage later down the line), then anything you can save after that is up to you.
posted by bcwinters at 11:33 AM on May 31, 2010

Nthing The Bogleheads Guide to Investing. And here is a link to the Bogleheads forum.
posted by Ryogen at 2:06 PM on May 31, 2010 [1 favorite]

I agree with what others have said, without knowing any more details, maxing out your Roth IRA is probably the best option. Also, one thing you should know specific to a Roth IRA is that you can remove your contributions at any time without penalty (which is different from a 401k or Traditional IRA), so that gives you a little more flexibility if you end up needing an emergency-emergency fund.

I'll also mention that as others have said, you can have a very diversified investment portfolio in a single IRA account. Diversification just means spreading out your investment over many different types of assets, so that you are not exposing yourself to big losses if one particular type of asset does poorly. That's why index funds tend to be popular, since you can invest in a very large range of assets with relatively low costs. In fact if you really want a "set it and forget it" type of investment, there are all-in-one funds like the Vangaurd Target Retirement Funds that will optimally balance your investments between a variety of stocks and bonds based on when you plan to retire.
posted by burnmp3s at 3:25 PM on May 31, 2010

Money going into a Roth has already been taxed. At a young age, you're probably earning less than you will later, and thus are subject to a lower tax bracket. When it comes out during retirement, it is NOT taxed. Your money will have grown tax free until then. Traditional IRAs are just the opposite. They're useful for high earners since deposits are deductible from taxable income, but they ARE taxed upon withdrawal.

You should be maxing out your Roth until your income warrants a traditional IRA, at which point you should max out deposits into BOTH each year.
posted by holterbarbour at 5:37 PM on May 31, 2010

You should be maxing out your Roth until your income warrants a traditional IRA, at which point you should max out deposits into BOTH each year.

Do you mean to say that a person can contribute the maximum amount ($5000) to each, every year? That is, $5000 in a traditional IRA, and also $5000 in a Roth IRA, for a total of $10,000 per year? My understanding is that you can set aside $5000, and you can put that amount in both (for example $2500 in a traditional and $2500 in a Roth), but the total remains the same -- only $5000 per year.
posted by Houstonian at 3:12 AM on June 1, 2010

Pay off any credit card or high interest loan bills before maxing out your IRA. Low interest loans like mortgage, student loans, even reasonable car loans are fine. It is important that maxing out your IRA not leave you without a safety net in savings. If you can not max out your IRA and have sufficient emergency funds, do not max out your IRA! Its better to have less in your IRA then to have to take out high interest unsecured loans because you lost your job/got sick/whatever.
posted by An algorithmic dog at 4:56 AM on June 1, 2010

Houstonian is right. I believe the $5000k/year limit applies to all the IRAs you have in your name, taken together.

Nthing max your IRA (but only if you're already maxing out a 401k match). One of the nice things about a Roth IRA is that you can withdraw your contributions (but not your profits, and you should only do this if you really need to) without a penalty, since you've already paid taxes on them.
posted by cosmic.osmo at 7:06 AM on June 1, 2010

Yeah the $5000 per year is all encompassing - regardless of institution, type, etc you can only invest $5000 in any IRA. There are higher "catch-up" limits for those over 50 ($6500). I am not sure of the implications for those filing their taxes as anything other than individuals. I don't believe the limit changes per person when you file as married, but I may be wrong.
posted by msbutah at 8:26 AM on June 1, 2010

My error. My income level not yet warranting a regular IRA, I was misinformed. You should be maxing out your contributions into your Roth until a tax deduction makes the regular more worthwhile. Then switch to the regular IRA.
posted by holterbarbour at 10:45 PM on June 3, 2010

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