An associate at work asked me which is better; saving in a tax-deferred 401K or a Roth IRA where your disbursements are tax-free? His young nephew had asked him the question. While both have their positives, I will say that bulk of my savings is in 401Ks and some that are transferred from a 401K into a Rollover IRA in brokerage accounts. Most of that was a result of my not being aware of a Roth IRA till much later. But would I have changed anything? And recently why did I start a Roth IRA?
The main advantages of a 401K are:
1. You can contribute money directly from your paycheck and if you don’t see the money, it is easier to save it.
2. It is taken out as pre-tax dollars and reduces your tax obligations year end.
3. Companies usually offer a partial match up to 3-5% of your contribution. That is free money one should take.
4. 401K being pre-tax dollars compared to a Roth IRA being post-tax dollars, a larger amount of seed money will multiply and grow much faster than a smaller amount.
5. The contribution limits for a 401K are $18,000 if you are below 50 with additional $6,000 catch up contribution if you are 50 or older. The contribution limit for Roth IRA is $5,500 and for 50 and over $6,500. Additionally you can also contribute to a spousal IRA if your spouse is not earning.
6. Finally, when it comes time to withdraw the 401K money in retirement, most of us will have less income for tax purposes and our tax rates will be smaller than when we were earning money. This is an advantage for a 401K versus Roth IRA.
So why put any money into a Roth IRA?
1. So why did I start a Roth IRA? I plan to day trade futures after I retire. I believe I can take a small amount of capital - as little as $13,000 and generate a $20,000 profit on it. By setting up a Roth IRA, I plan to make this money tax-free.
2. There is no harm in having both 401K and Roth IRA accounts.
The clear winner seems to me 401K. Feel free to comment on this blog post if you agree or disagree but this is how I see it!
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ReplyDeleteMany good points. Couple of other variables for his nephew to consider: Does the company where he works offer a "Roth 401k" with matching? Where I work that is another option.
ReplyDeleteAnd what is his marginal tax rate? Is it lower now than where someone may be in their retired years (like a first-year employee, maybe married)? The tax rate now may be better than when retired. We really won't know.
The options in his workplace 401k may be limited or come with significant fees. In that case contributing only up to capture the full matching makes sense. Then contribute the difference that he can afford to the outside Roth IRA. That may also have the benefit of diversification.
The after-tax Roth IRA also comes with more flexibility when retired. There are no Required Minimum Distributions (RMDs) at 70-1/2 years old and later.
Depending on the post-retirement tax bracket, the Roth IRA withdrawals can be used to avoid going into a higher tax bracket if other taxable withdrawals or side job incomes in retirement push income close to more painful tax brackets.
Lots to consider!
Roth may be good for people expecting to earn income from other sources and or plans to work beyond 70s and 80s. For people getting less then 100k with no side income in retirement married with standard deductions may be in a lower tax bracket in retirement. Personally I feel 401k is better
ReplyDeleteI am very fond of different means of Investing my money. Recently I came across Gold IRA investment. Then I started searching for best gold IRA companies in the States. Do you know any?
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