Most people know what both the Roth IRA and 401(k) are, and how they differ. But many people get confused as to which they should max out first in their own situation. Although there is no set rule that works for everyone, there are a few pointers that can get you started in what works best for you.

First off, even calculating everything now and coming up with what seems like a good answer, you might be wrong. Why is that? No one can predict the future, we don't know what the tax brackets will be in the far off future. We don't know if the Roth will still be around or work the same way after 2010 (see mm's post). And although we can try to predict, we don't know for sure what our own financial situation will be when we do retire. That being said, using what we know now we can follow some general rules that should work out to our benefit in the end.

For those that don't know, a 401(k) is an employer sponsered plan that allows you to contribute pre-tax dollars, and allows that money to grow tax free until you withdraw it. Once you withdraw it, you will be taxed at your income tax rate at that time. Many companies also offer a match when you make contributions to your 401(k). For example, if you contribute 5% to your 401(k) your employer might match that and put in another 5%. 401(k) plan vary, but you are limited to the investment options provided in that plan. In some plans, like one I used to have, the investment options were not in the impressive category.

With a Roth IRA, you are contributing after-tax dollars, and that money will grow tax free. When you withdraw the money after retirement, you will pay no taxes on it (at least according to today's laws). There are many different ways to set up a Roth IRA, but for the most part you have much more control over your investments than you would with a 401(k).

Now, the first very obvious rule is to take advantage of your employers 401(k) match. If you get a dollar for dollar match up to 5%, and you contribute 5%, you are getting an immediate 100% return on your money (assuming you stay long enough to get vested). Earning 10% a year, it takes 7 years to double your money in any other investment, so the money your employer matches really puts you ahead of the game. So a general rule for almost everyone is to contribute at least as much to your 401(k) that you get the max matching contribution from your employer. Why give away the chance for free money?

The next thing you'll need to look at is your tax bracket now vs your tax bracket in retirement. That will pretty much tell you which investment option to max out first. If you expect to be in a lower tax bracket in retirement than you are now, you'll want to put more in your 401(k). If you expect to be in a higher tax bracket, the Roth might be the best option.

In my case, I've planned my savings so that I'll be able to retire at age 60 at about the same income level that I have now (inflation adjusted). If my wages rise higher than inflation in the future, it will likely push my retirement date younger rather than increase retirement income. The difference for me is that now I have a mortgage payment, a child, wife's student loans, child's college plan, etc that all give me large tax deductions. I don't expect to have any tax deductions in retirement, so although my income will be roughly the same I will probably be in a higher tax bracket in retirement than I am now.

So for me, my priority is:

1) 6% contribution to 401(k) (this get's me a 5% match)
2) Max out Roth IRA
3) Max out my wife's Roth IRA
4) Max out my 401(k)
5) Max out my wife's 401(k) (no company match, if her company starts matching this will move up to #2)

Some people might ask why I would max out my ROTH before contributing any to my wife's ROTH. The answer is that both of our IRAs are held at a brokerage where I handle all the investments. It's better for me to have $5000 in one account rather than $2500 in two accounts so that I don't get hit as hard with commission fees. (i.e. if I wanted all $5000 in SPX I would have only one commission fee in my Roth vs two commission fees if the money was split.mortgage calculator