Start young, make most of Roth, 401(k)

Q: I was wondering if you could point me in the right direction in regards to which retirement account would be better.

I'm 27 and currently contribute a little more than 10 percent of my income to my 401(k) account; my employer matches the first 7 percent in this account. I have been reading a lot lately about Roth IRAs, so my question is: Which is better, a 401(k) or Roth IRA? Or should I do both?

I have some money sitting in my checking account and haven't filed my taxes. If you think I should contribute to a Roth IRA, do I have time to make a contribution for 2007? Should I set it up at my bank? I would appreciate any help you could give me.

A: It is pretty impressive that you are investing 10 percent of your income for the future at age 27!

If you can afford to contribute to your 401(k) and a Roth IRA, that would be great. Contributing enough to your employer's 401(k) plan to obtain the match and then investing what you can in a Roth IRA is probably the best financial decision.

I say probably because the advantages of investing after-tax money in a Roth IRA versus investing pre-tax money in a 401(k) plan are greatest if you think you will be in either the same or a higher income tax bracket in retirement.

Many people automatically assume that they will be in a lower tax bracket in retirement, but this assumption may not be correct. Income sources from pensions, dividends, realized capital gains, social security benefits, annuity payments, withdrawals from traditional retirement plans and rental income will all affect your tax bracket in retirement.

In addition to estimating all expected taxable income in retirement, you also have to make assumptions about future changes to the tax code. Many financial advisers think that future tax rates will increase because of the large government budget deficit. At your age, your income will likely rise, and in the future you may not be allowed to contribute to a Roth IRA.

Single or head of household taxpayers may make a full contribution to a Roth IRA if their modified adjusted gross income is under $99,000 and a reduced contribution if their income is between $99,000 and $114,000. No contribution is allowed for those with adjusted gross income above $114,000. The income range for joint filers is $156,000 to $166,000.

The maximum contribution is $4,000 for tax year 2007 and is $5,000 for 2008. Taxpayers who are 50 or older by the end of the tax year for which they are contributing can make an additional $1,000 catch-up contribution.

You have until Tuesday to make a contribution for 2007. You could open the Roth IRA account at your bank and fund on or before Tuesday. Tell them you want the money kept in a cash equivalent investment with no front-end fees and no surrender charges. This will meet the looming deadline for funding the IRA and give you some time to decide where you ultimately want to invest this money.

The bank will have access to different investments, but you most likely will pay a sales charge when you invest. If you want to save on fees, research no-load mutual fund families for a highly rated fund with an investment objective with which you are comfortable that complements your 401(k). Once you decide on a fund family, initiate a direct trustee-to-trustee transfer from the bank to the fund family. The fund family can assist you with this transfer.

If you don't want to or don't feel comfortable doing your own research and want to invest in no-load mutual funds, meet with a fee-only adviser. You will pay for the advice, but you won't be paying a fee every time you make a contribution to the suggested funds.