Where to Invest First to Jump-Start Your Retirement Savings

Most public-sector employees have several tax-favored retirement-savings options. You may be able to contribute up to $15,500 to a 457 deferred-compensation plan in 2007, for example, plus $4,000 to an IRA. It would be best if you could contribute the maximum to both plans, but even if you can’t invest that much when you’re just starting out, it’s still important to contribute whatever you can. So where should you save first?

Your 457 and IRA are both great retirement-savings plans, but each one has different tax benefits and accessibility rules. Here’s what you need to know when deciding which plan to focus on first.

The benefits of a 457. It’s simple to get started and manage your 457 plan - there’s no minimum investment and the money is automatically deposited from your paycheck. If your employer matches your contributions, then your first priority should be to invest at least enough each year to get the full match. Free money is tough to beat. Your contributions to a 457 can lower your taxable income and reduce your paycheck by less than you might expect: Investing $100 per month lowers your take-home pay by only $75 if you’re in the 25 percent tax bracket, for example. You don’t pay income taxes until you withdraw the money, which is valuable if you expect to be in a lower tax bracket during retirement. After you leave your job, you can withdraw money from a 457 at any age without a 10% early-withdrawal penalty, even if you’re younger than age 59½. You will have to start taking required minimum distributions after age 70½.

The benefits of an IRA. You can contribute up to $4,000 to either a traditional IRA or a Roth. The tax benefits of a traditional IRA are a lot like those of a 457: Your earnings grow tax-deferred until you withdraw the money in retirement and, depending on your income level, your contributions may be tax-deductible. The traditional IRA, however, doesn’t have the flexibility of a 457 - you’ll generally owe a 10% penalty for withdrawals before age 59½.

A Roth IRA is very different. It provides no upfront tax break, but you won’t owe any income taxes on the earnings if you withdraw the money after age 59½ and have had a Roth for at least five years. And you can withdraw your contributions at any time tax- and penalty-free. These tax-free withdrawals are most valuable if you expect to be in a higher tax bracket when you take out the money. A Roth IRA is also a good choice if you plan to keep the money in the account for a long time - it has no minimum distribution requirements at any age, and your heirs can inherit money from your Roth without owing income tax.

You can qualify for a Roth only if your modified adjusted gross income in 2007 is less than $114,000 if you’re single, or $166,000 if you’re married filing jointly, with the contribution amount phasing out for singles earning more than $99,000 and joint filers earning more than $156,000.

For help choosing between a traditional and a Roth IRA, see the IRA calculators in the Planning & Tools section.¹

¹ The No-Fee Vantagepoint IRA has a low initial minimum investment of $1,500, which is waived if funded through the convenience of an automatic investment program.