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Jim Cramer says you should never pass up any free cash your employer may offer to build for retirement.
"If the company you work for offers an employer match for your 401(k) contributions, then you want to put money into your 401(k) until that match is maxed out. No reason to pass up free money," the "Mad Money" host said. "And after that, put any additional retirement savings in an IRA."
The reason that workers should max out their 401(k) contributions is because the investment comes from pretaxed income. Before a paycheck is distributed, a certain amount is held back before it is added into the retirement ledger.
The tax-free investment covers both income tax and capital gains taxes on profits. A tax is only applied once when money is withdrawn in retirement, Cramer said.
"That's free money, people. It's also untaxed," he said. "So if your employer even partially matches your contributions, you should absolutely take advantage of it by putting money in your 401(k). No question."
There are some negatives, however, when it comes to 401(k) plans, including the fees charged by both the mutual fund and the 401(k) administrator, who is hired by the employer.
Still, stashing away $5,000 of untaxed money annually over three decades into the retirement plan could compound to more than $511,000 for life after work, Cramer noted.
"But if your 401(k) doesn't have any kind of employer match, then I think it's a much less compelling option, because, as I said before, 401(k) plans can have a lot of problems," he said. "Without the match, you're much better off saving for retirement via an Individual Retirement Account, or IRA, which has the same exact tax-favored status as a 401(k)."
Retirement isn't the only important goal for long-term investing. Cramer said he has read a lot of stories lately that talk about the growing burden of student loan debt for tens of thousands of Americans who owe more than a trillion dollars in debt.
"For any of you who are parents or are thinking of becoming parents, let me just tell you right now that there are very few things you can do for your kid's future that are better than paying for as much of their college education as you can afford," he said.
Hands down, the best way to save for college is with a 529 plan. Rules vary by state, but certain aspects are standard across the country.
Due to federal gift tax laws, single investors can only contribute $14,000 a year, or $28,000 if you're married and file taxes jointly. Grandparents can contribute to the plan, as well, and can even start a 529 plan with your child as the beneficiary, though Cramer says it is better for a parent to do it.
"The key here, though, is that you want to get that money into your kid's 529 as early as possible," Cramer said. "That's because the greatness of these plans is all about the power of compounding."
With so many options out there for mutual funds and exchange-traded funds, your head could be spinning. How the heck are investors supposed to know which ones to invest in when there are so many of them?
"The important thing is this: You have all sorts of ETFs and mutual funds out there and they can all advertise," Cramer said. "Companies that run these funds want your money. And one of your biggest mistakes you can make as an individual investor is to give it to them, with a few significant exceptions."
If you are an investor who owns mutual funds, Cramer says you are probably getting hosed. There is just no other nice way to put it.
However, his beef is not with all mutual funds. Specifically, he warned against actively managed mutual funds with people deciding the stocks and securities to buy and sell.
Cramer has an issue with actively managed funds because the managers don't get paid for delivering performance — they collect a fee from investors regardless of the amount of money they make for their client.
The amount of money they make depends on the size of assets under management. That means their biggest incentive is not for an investor to do well; it is how much of your money they can bring in.
According to Cramer, it does not matter how good an investor is at picking stocks. If the funds are kept in the wrong account, tons of money could be wasted in hidden fees and opportunity could be missed.
This logic is especially applicable to 401(k) and IRA retirement accounts, and whether it makes sense to use a Roth account.
"I think that aside from the earned income tax credit, the Roth IRA may be the single-greatest thing our government has done for low-income families since the end of the war on poverty, which at best, ended kind of in a draw [with] poverty possibly winning on points," Cramer said.
Deciding between a Roth IRA or 401(k) or a regular IRA or 401(k) depends on whether it makes more sense to pay income tax now or after retirement. This is a complicated decision that has more to do with the specifics of a situation and whether one anticipates they will be in a higher tax bracket at retirement.
With a Roth, contributions are made with after-tax income and the money in the Roth IRA will not be taxed again. There is also an income limit, depending on if you file jointly or as a single. According to the IRS, contributions to traditional and Roth accounts cannot exceed $6,000 for individuals under age 50 and $7,000 for those over 50.
As long as the cash remains in the Roth account, you will not pay dividend tax. The money can then be withdrawn without a penalty after age 59½.
Another perk to a Roth IRA is that after five years, money contributed — not your gains — can be withdrawn without the usual 10 percent penalty. This is different from a regular IRA, where there are no taxes on contributions until money is withdrawn.
"For anyone whose marginal tax rate is 25% or less, which is most of America, I think you go with Roth. Better to take the hit up front, then allow your Roth IRA to compound tax free for the rest of your life," Cramer said.