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Your 401(k) plan is unquestionably a great vehicle for building retirement savings. You typically fund your plan with pre-tax dollars, so your contributions can lower your annual taxable income. Plus, your earnings grow on a tax-deferred basis. So, you should always put in as much as you can afford to your 401(k), right? Not necessarily.

Why? Because you may be able to get more "mileage" out of your retirement plan dollars by putting some of them into a Roth IRA. As you may know, Roth IRA earnings have the potential to grow tax-free, provided you've held your account at least five years and you don't start taking withdrawals until your reach age 59 1/2. Furthermore, when you invest in a 401(k) or a similar plan (such as a 403(b) or 457 plan), you may be required to take minimum distributions when you reach 70 1/2, but you can let your Roth IRA keep growing until you decide when to take withdrawals.

Do you have to choose?
Clearly, both a Roth IRA and a 401(k) offer significant advantages to you as you build funds for retirement. And, fortunately, you don't have to choose one of these vehicles over the other. So, how should you divvy up your contributions?

Here's one suggestion: Put as much as necessary into your 401(k) to earn your employer's matching contribution, if one is offered. Then, fully fund your Roth IRA. If you "max out" on your Roth IRA, and you still can afford to set aside more funds for retirement, increase your 401(k) salary deferral. (In 2005, you can put up to $4,000 into a Roth IRA, or $4,500 if you are 50 or older. You can also defer up to $14,000 to your 401(k), or $18,000 if you are 50 or older.)

Of course, this strategy may not be applicable if your income is too high to contribute to a Roth IRA. If you are a single filer, you can put in the full amount to your Roth IRA if your modified adjusted gross income (AGI) is less than $95,000 per year, and you can make partial contributions if you earn between $95,000 and $110,000. If you are married, and filing jointly, you can contribute the maximum to your Roth IRA if your AGI is less than $150,000 per year; you can make partial contributions if your AGI is between $150,000 and $160,000.

Keep diversification in mind
If you can contribute to both a Roth IRA and a 401(k), you'll need to carefully choose the investments that make up these respective retirement plans. You won't want to "duplicate" your holdings by choosing virtually identical investments in your Roth IRA and 401(k). Instead, seek to diversify as much as possible. For example, if your 401(k) is made up mostly of aggressive growth vehicles, you may want to fund your Roth IRA with somewhat more conservative investments. Your individual asset allocation should depend on your risk tolerance, long-term goals and time horizon. Just keep in mind that your Roth IRA and 401(k) are two pieces of a bigger picture.

By wisely integrating your 401(k) and your Roth IRA into your overall investment strategy, you can go a long way toward achieving your ultimate goal - a comfortable retirement lifestyle.

This article has been reprinted with permission of Invstment Representative Celine Richardson of Ithaca's EdwardJones Office

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