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401(k) or IRA: Cramer’s rule to remember

(Click for video linked to a searchable transcript of this Mad Money segment)

Is the company 401(k) a better way to invest for retirement? Or should you go with an IRA?

Jim Cramer knows millions of American struggle with this very issue. And he understands why.

"There are very good things about a company's 401(k)," said Cramer. "But there are some bad things, too."

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The big positive, he said, is that a 401(k) is a tax-deferred vehicle. "You pay no taxes on what you put in, and then you never pay a penny of capital gains taxes on the profits you make within your 401(k), which allows your money to compound year after year, decade after decade, totally tax-free until you decide to start making withdrawals."

Therefore, Cramer says if someone who is 30 years old invests $5,000 a year over the course of 30 years, he or she will have far more than the $150,000. "By my calculations the investment could be worth well over $500,000 depending on the way in which the money is invested" due to the tax deferred status and the power of compound interest, Cramer said.

The second big positive, Cramer said, is that employers will often match 401(k) contributions. "And I never like to walk away from free money," he said.

However, the negatives are significant, too.

Often times, "401(k) plans have high management fees and administrative costs that eat into your returns," Cramer said. "Also, 401(k) plans typically offer limited choices for your investments, with little or no control over them," Cramer added.

So, when trying to decide between a 401(k) plan and an IRA, Cramer says if an employer matches your contribution, and if the plan provides at least some flexibility, go with the 401(k) until you've maxed out the match.

However, after that, Cramer says, "I believe the rest of your retirement investing should happen in your IRA until you hit the upper limit on what you're allowed to contribute in a given year," Cramer said.

That's because an IRA allows you to actively manage your own money, and that's something Cramer believes can significantly augment your wealth over the long term.

That is, Cramer believes whole-heartedly that owning five to 10 stocks of good companies, with solid balance sheets, strong industry position and quality management is the best way to invest for retirement.

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Of course, this is a general rule. Your specific circumstances may warrant a different strategy. But broadly, Cramer says the match trumps the negatives associated with a 401(k). However, after the match is exhausted, choose an IRA because it gives you more control of your financial destiny.




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