Roth IRA & 401k

[Hector]

Hi All,

We built our emergency account that we feel comfortable about.
Now we are going to take next step and start savings towards retirement.

Should we allocate funds into Roth IRA or into 401k ?

Company doesn't match towards 401k. I think, Roth is obvious choice, but I am tempted towards 401k because of INSTANT tax advantage.

We(my wife and I) can't afford to put more than 10k/year, so max out Roth and add some into 401k is not an option.

Thanks

[littleroc02us]

One way I would look at it is that when you retire will you be in a higher tax bracket or lower, the reason I ask is that if you'll be in a lower than it pays to put as much as you can into the 401k because when you withdrawl someday your taxes will be at a lower percentage then they are now. Whatever the remainder of your investment amount put into Roths for both of you. I personally max out my 401k at 5% and my employer matches and then my wife and I max out our Roth's each year.

[disneysteve]

I'm of the opinion that taxes are bound to go up so I'd rather pay them now and never have to worry about them again (Roth). That said, it depends on your current income and tax situation. It could be more advantageous to avoid taxes now. I'd just rather pay them and be done with it.

[jpg7n16]

Nothing says you can't do 50/50.

You should probably do the employer match, then if you're not sure which one is better - do half and half.

For instance, you want to save 15% and the company matches 3%. So put 3% in the match. 12% left to go so.... 6% in Roth, 6% in 401k.

Simple to remember and gets the best of both worlds!


If the decision is that close, either way can't be too wrong, so 50/50 works out perfect from a planning standpoint.

[parafly]

The Roth is a better choice for the vast majority of people. Unless your 401K contributions will drop you into a lower tax bracket, it's a no brainer.

In a Roth IRA all of your growth (compounding interest) is tax free whereas in a 401K all of your growth is taxable. In the end the tax savings of a Roth IRA will far outweigh the potential tax savings of a 401K for most people.

A Roth IRA typically gives you more flexibility in regard to fund choices, and it also gives you the ability to withdraw contributions at any time without penalty. It's not recommended, but it's an option in dire times.

[Hector]

Originally Posted by parafly

The Roth is a better choice for the vast majority of people. Unless your 401K contributions will drop you into a lower tax bracket, it's a no brainer.

In a Roth IRA all of your growth (compounding interest) is tax free whereas in a 401K all of your growth is taxable. In the end the tax savings of a Roth IRA will far outweigh the potential tax savings of a 401K for most people.

A Roth IRA typically gives you more flexibility in regard to fund choices, and it also gives you the ability to withdraw contributions at any time without penalty. It's not recommended, but it's an option in dire times.

Makes sense. Though I believe in Random Walk Down Wall Street theory, I would prefer to pick individual stock/ETFs and for that Roth is more suitable.

[MonkeyMama]

I'd vote rather 50/50. If you are on the young side, the ROTH will probably win by a mile. The risk is what will happen to the ROTH in the long run. Taxes change all the time. The ROTH is a once-in-a-lifetime kind of deal - but I wouldn't be surprised if the government eventually meddles with it.

On the flip side, one can argue never to give up a current tax break for the promise of a future tax break. Wise words.

For me, at the moment, all I have access to is IRAs. We have decided to max out our ROTHs for now. But, I have about 50% of my retirement in regular IRAs from old 401ks, etc. So, I feel we run pretty 50/50. BUT, the current tax break isn't very lucrative to me. If I were actually in the 25% tax bracket, I'd probably choose the 401k, hands down.

Oh - and another thought! Put $10k into the 401k, and use the tax savings to fund a ROTH. That is precisely what I would do in your shoes. Unless you were in a low (15%?) tax bracket. Then I'd probably just do the ROTH, and put any raises in the 401k. Eventually you will get to putting a fair amount in both, either way.

[Hector]

We fall in 25% tax bracket and live in CA (state tax bracket is around 10%)

Right now I am thinking about contributing 10k (effectively 6.5k from pocket) by April 2011 towards regular IRA for the year 2010.

[jpg7n16]

Originally Posted by MonkeyMama

I'd vote rather 50/50. If you are on the young side, the ROTH will probably win by a mile. The risk is what will happen to the ROTH in the long run. Taxes change all the time. The ROTH is a once-in-a-lifetime kind of deal - but I wouldn't be surprised if the government eventually meddles with it.

Why do you think that the Roth will win by a mile the younger you are?

[jpg7n16]

Hector- you could move to Texas and save 10% on your income instantly

The problem is that for Roth, you contribute money that is taxed at 25% guaranteed (+10).

But the 401k stops you from being taxed 25%, and in the future when withdrawn (if no other income) begins being taxed in the lowest bracket, and you can use deductions against that income. So some of it may not get taxed anyways. And if it does, it's at the lowest bracket 1st.


I think somewhere in the middle is best honestly. It doesn't have to be all or nothing. And given the high level of taxes you're facing, I'd lean towards 401k. But 50/50 is fine. 60/40 would work too. Whatever makes you comfy.

[MonkeyMama]

Originally Posted by jpg7n16

Why do you think that the Roth will win by a mile the younger you are?

Tax free growth/earnings. The ROTH is far more lucrative if you are younger and can let it grow a few decades, tax-free.

This is presuming you put the same amount in a ROTH vs. 401k or Traditional 401k. If you can put more into a 401k or Traditional IRA, because of the current tax breaks, then that is another story.

[MonkeyMama]

Originally Posted by Hector

We fall in 25% tax bracket and live in CA (state tax bracket is around 10%)

Right now I am thinking about contributing 10k (effectively 6.5k from pocket) by April 2011 towards regular IRA for the year 2010.

I'd probably do the same. On paper, the ROTH looks pretty good. (As a tax professional in Cali, I have serious doubts your future tax rates will be lower - even in retirement). But saving $3.5k now, in taxes, sounds more warm and fuzzy.

I actually contributed to a 401k in your shoes and converted that money to ROTHs when my spouse was unemployed and we were in a lower tax bracket. win-win.

[jpg7n16]

Originally Posted by MonkeyMama

Tax free growth/earnings. The ROTH is far more lucrative if you are younger and can let it grow a few decades, tax-free.

This is presuming you put the same amount in a ROTH vs. 401k or Traditional 401k. If you can put more into a 401k or Traditional IRA, because of the current tax breaks, then that is another story.

Well yeah, $5k in a Roth is worth more than $5k in a 401k - even with no growth. Cause if you withdraw the 401k, you're taxed.

But 401k's grow tax-deferred too. They get the same decades of tax-free growth that Roth's get.

The 401k gets the same growth, but has more money in play because it hasn't been taxed yet. For an average tax bracket of 25%, $5000 in the 401k should be compared to $3750 in the Roth.

Stated another way, if you're able to save $3750 in your Roth, you would have been able to save $5000 in the 401k - with no effect on your budget whatsoever.

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So over 40 years, you could have $3750 in the Roth, which at 8% would grow to a tax free value of $81,466.96

But you could have had $5000 in the 401k for 40 years, which at 8% would grow to 108,622.61. Pay 25% in taxes, and you're left with the same $81,466.96.

Your age doesn't really matter much in the decision, cause they wash out.

Or even still, I don't need to be young for $5000 tax free to be worth a lot more than $5000 taxable.


I think I see what you were getting at though. I just think the Roth is occasionally touted as having magical powers for making your money able to grow faster than it would in your 401k. So wanted to make that distinction.