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As another post indicated, being eligible to contribute to a 401(k) greatly reduces the income level at which you can no longer deduct contributions to a Traditional IRA. But if your friend's income is low enough, she can certainly contribute to both and enjoy the tax deductions to both (the 401(k) contributions, if pre-tax, reduce the income reported on W-2, box 1; she would have to show deduction for a Traditional IRA on form 1040 or 1040A).

Many people find that if they have a 401(k) avalable, they cannot deduct contributions to a Traditional IRA because of their income level. If that is the case, a Roth IRA is generally better than making non-dedictible contributions to a Traditional IRA. But if your income is too great to contribute to a Traditional IRA, you can still contribute to a Traditional IRA if you have earned income and you aren't turning 70.5 years old in the current year.

The general advice is usually:

1. Top priority for retirement funds is to contribute to an employer's plan (401(k), 403(b), or the like) up to the matched amount. This is like an instant return on investment or like free money--actually it is part of one's compensation package--so it is usually good to make use of the employer's match.

2. Next priority for retirement funds is usually to contribute to one's Roth IRA. Since your friend can open a Roth IRA with just about any financial institution, she isn't restricted to what her employer provides in the 401(k) or 403(b), so she could pick the best place to hold the IRA to get the best investments or savings instruments one wants that is consistent with one's investment plan. Often this means one can find a place with lower expenses and thus better returns, or be able to bring in diversity that one doesn't have in the employer's plan.

3. The next priority for retirement funds is to consider whether to contribute more to the employer's plan (401(k), 403(b), or the like). Some plans are pretty expensive (high fees, high expense ratios) that may swamp the tax advantage in the long run, but even with high expenses it might make sense if one is planning on leaving that employer in a few years, at which point (i.e., at separation of service), one can roll over the employer's plan to a "rollover IRA" (a Traditional IRA funded with strictly 401(k) or 403(b) money).

4. If one still has money to invest for retirement (beyond #3 or having skipped #3, or even want some assets that could be used before retirement), one may consider whether to invest in a personal (taxable) account or, if one owns a home, pay down the mortgage. One doesn't get the immediate tax advantage of #1 or #3, nor the tax free growth of #2, but one does have the flexability of putting that money in almost any investment in the investment universe, no contribution limits, no withdraw restrictions (other than what the particular investment might impose).

The above should be considered no more than a general rule of thumb--individual situations may suggest different priorities. For example, if one is in an occupation that tends to attract lawsuits, one might reprioritize based on creditor protection, and 401(k) and 403(b) plans generally have ERISA protection (protected from creditors, except for IRS back taxes and domestic order decree from a divorce), whereas protection for IRAs (Roth and Traditional) vary based on state law. Or one might make a Roth IRA top priority because one can withdraw regular contributions from a Roth IRA at any time for any purpose, no tax, no penalty. (My preference is to have a separate savings for emergency and keep the Roth IRA money invested for its intended purpose: retirement.) Or if one expects one's retirement tax rate to be lower than one's working tax rate, one may want to prioritize all employer plan contributions before Roth (so taxes get deferred on the 401(k) & 403(b) until retirement), provided that the expenses aren't too high.

Here are a couple links that may be of additional help:

"All About IRAs" <>

IRS Publication 590: Individual Retirement Arrangements <>
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