What's Better 401(k) or Roth IRA?

What's Better 401(k) or Roth IRA?
by: Rocco Beatrice



One of the most frequently asked questions planners get about retirement
planning is what's better for retirement planning: a 401(k) or a Roth
IRA. The answer may not be as straightforward as it might seem.

WHAT ARE THE OPTIONS?

401(K)

Under section 401(k) of the IRS code, a 401(k) is an employer-sponsored
deferred contribution plan for retirement. In your workplace, you set up
a 401(k) plan with human resources and choose options within the defined
plan. Your employer takes money out of your paycheck prior to income
taxes being taken out and deposits this into your 401(k) plan. Some
employers even match your contributions. When you retire, you can decide
to withdraw money out of the 401(k), but those withdrawals are subject to
income tax when they are taken out 10,20, 30 years later. Currently,
there are no income limitations on who can contribute, but an individual
can contribute at most $15,500 to their 401(k) in 2008. $46,000 is the
maximum aggregate amount that can be contributed between employer and
employee in 2008.

ROTH IRA

Senator William Roth was the chief sponsor of this movement. A Roth IRA
is an individual retirement account independent from your employer that
you create directly with a custodian firm. After a Roth IRA account is
set up, these plans have a much wider investment selection typically, and
then directly deposit after-tax money from your checking account into the
Roth IRA. Then, after you turn 59 1/2 years old and have had the plan for
at least five years, you can withdraw from the account entirely tax free.
In 2009, the maximum you can contribute is $5,000 a year (unless you're
over 50). There is one big qualification: if you make more than $99,000
individually or $156,000 as a married couple, you cannot contribute the
full amount (and may not be able to contribute at all).

401(K) OR ROTH IRA: THE LARGEST DIFFERENCES (PROS & CONS)

The largest differences between the two plans are workplace
contributions, investment options/management, and taxes. Let's walk
through each feature.

1) Workplace contributions - Employers with a 401(k) retirement plan may
or may not match contributions made by an employee. For example, a 401(k)
program may offer a 50% match for every dollar the employee contributes
to a 401(k) up to 4% of the salary. Therefore, if the employee
contributes 4% of their salary to their 401(k), the employer also puts in
an extra 2% of your salary, effectively increasing your contribution by
50%. In short, employers that offer matching contributions to your 401(k)
should be revered. This typically trumps any other consideration
regarding the decision to contribute to a 401(k). It's free money, like a
year-end bonus that comes every 2 weeks - don't turn it down.

2) Investment options - With a 401(k), you're forced into whatever
management and investment options are offered to you by the plan your
employer offers which usually mean the investment choices are restrictive
and expensive. Things to watch out for in these investment plans are
mutual fund expense ratios and investment options. A Roth IRA is
extremely flexible and allows one to choose investment options - you even
pick the custodian you want to use. Roth IRAs offer an advantage with
regards to flexibility of investment choices, though if your 401(k)
offers solid options, this may not be a great advantage – but most
don't.

3) Taxes - This is really the tough one out of the three because it
involves a level of prediction of what the future holds for you. If you
think your income tax rate will be higher at the time of withdrawal than
it is currently, a Roth IRA is the better choice and will save you in the
long run.

How can someone expect to know future tax rates? Here are a few things to
consider:

Will my income grow significantly between now and retirement? If you
believe it will, you'll likely be in a higher tax bracket at that time,
which favors the Roth. If you feel that you are near your peak, you'll
probably be in the same bracket or lower, which could favor the 401(k).

Do I expect to be working in my retirement years? If you believe that you
will, you have a high chance of being in the same tax bracket or higher
than you are now. If the answer is no, likely your income will be lower.

Will the political landscape shift towards higher tax rates? It is easy
to speculate that with the expected budget deficits, tax rates will go
up, and that favors the Roth IRA. If you believe they will decline, that
would favor the 401(k).

401(K) OR ROTH IRA: SO WHAT SHOULD I DO?

If your employer offers 401(k) matching, always max it out. This is free
money.

The question really revolves around what to do with additional retirement
money. Given all the above factors, and also assuming you're young and
have many years of income growth ahead of you, a great option is a Roth
IRA.

Finally, there are other tax-free retirement options to consider such as
Roth IRA on Roids for slightly more sophisticated investors. It has all
the benefits of a Roth IRA with no restrictions and guaranteed principal.

Whichever you decide to pursue, by simply putting money away, you're
ahead of the game. Don't let the deliberation keep you from saving - if
all else fails, start making contributions immediately to one or the
other now and then finalize decisions later - you can always change your
mind in the future.






About The Author
Best IRA Rescue provides services on your IRA investments and traditional
IRA and will help you reduce your inherited and beneficiary independent
retirement account taxes in your estate assets. Roth on ROIDS is your
advanced Roth IRA retirement planning strategy and one of the best IRA
tax-savings strategies with benefits of a guaranteed death benefit,
guaranteed principal, tax-free growth, and tax-free distributions from
policy loans.

Contact us if you have any questions on your IRA retirement planning.
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