401K or Roth IRA

[BAGAGT1]

Hi all,

My wife is starting a new job next week, the new employer offers a good 401K program, where they match .50 cents on the dollar up to her first 6%. My wife and I have established that she should save at least 10% of her salary in the 401K, but now I am having second thoughts. Would it be a better decision to only save the 6% in her 401K to get the full company match and then contribute the remaining 4% in a Roth IRA?

I find a little background info always helps when soliciting advice so here it goes. My wife and I are both in our early 30's, I have managed to build a fairly decent retirement fund (I save 10% in my 401K, and started a Roth IRA last year) in just six years. My wife has a small rollover IRA (less than 10K) from one of her previous employers 401K program. We own a home, and both have decent cars (one will be paid for in October), and our CC debt will be paid for next month, so we are not really saving for anything in particular other than retirement. We also have a fairly decently sized emergency fund, that should be able to carry us through for one year if one of us should loose our job.

We have been discussing the prospect of possibly starting a family in the future, so I do like the prospect of not being locked into a 401k. However, I have seen how quickly my 401k has grown in just six years. I'm leaning on the Roth IRA, but I would like your opinoins......

[Tree0164]

I think doing the match to the 401k and then contributing the rest to a Roth is a solid strategy for having after-tax income when you retire.

The upside of the 401k is that it is taken directly from your paycheck and you never see the money. With the Roth, it is like another monthly bill and it can take discipline to put in each month. You can do a yearly deposit or most companies that Roth you can do an automatic monthly deposit.

My hubby doesn't have a Roth but I do. I don't have access to a 401k so we I contribute money into a Roth while hubby puts in 10% to his 401k at work.

[34saving]

Well, it looks like right now you guys are falling into the "dual income, no kids" category, so I'm betting your taxes are pretty high? If so, you might want to put more into the 401K than the Roth (for sure enough to take advantage of the match.) If/when you have kids the Roth is more flexible and since your taxable income will probably be lower (either one less income or daycare) the tax issue will be less significant.

Wow . . .that's a toughie . . .usually I'm a huge Roth fan, but I think in this case I'd probably put more into the 401K. Of course, if you can max both that's aways good too

[BAGAGT1]

Originally Posted by 34saving

Well, it looks like right now you guys are falling into the "dual income, no kids" category, so I'm betting your taxes are pretty high?

Yes they are.

Originally Posted by 34saving

Of course, if you can max both that's aways good too

Maybe in another year and a half, but we'll have to finish paying the other car, and some furniture before that happens.

[obi_positive]

I have a 403b currently with some pretty decent funds, however a previous employer's 401k had a really lousy selection. But with a Roth, I'm in total control (I'm a Type A personality anyway). So I'm partial to funding up to the match on the 401k, then choosing your own funds on the Roth.

[CRFSaver]

The great thing with a 401 K is it is taken out pretax. Your money grows pretax. Your roth is post tax. You would have to fund an extra 28% (a guess as to your marginal tax rate) to get the same benefit as funding it pretax. While the earnings are not taxed on a Roth, theoretically in retirement your tax bill wont be as high so the benefit is less. Unless you feel that you may need those funds out of the Roth (for a home for example) I would fund your 401K to the max and do additional deposits into a Roth after that.

[jmjj215]

With deciding bet. a roth and a 401k (above the obvious no-brainer employer match), it all comes down to your tax rate. If you think your tax rate will be higher in retirement, then you'll want to do a roth. If it will be lower, you'll want to do the 401k.

One thing though. Uncertainty about future tax rates certainly legitimizes a "discount" to your 401k return upon retirement. You should properly build this into any comparisons you might be doing. What after-tax % return is worth the risk that rates will be higher than what you anticipate, making the roth the ideal choice?

[CRFSaver]

Good Point JMJ. I have never done the math to calculate the break even point of those scenarios. I just look at it from the point of the present value of a future dollar. The closer you get to retirement the more likely a Roth makes more sense. As I am a good 30 years from retirement those extra dollars going into my 401K make sense from my point of view.

[gakline]

I'm with Jesse on the tax bracket issue. I have had a Roth account for the past 7 years (since inception in 1998 and I was 18). I look at it as my tax bracket will be definately be higher when I retire 40 years from now. When I started saving, I was a college student with little income, low tax bracket. Now that I'm done, I'm in a much higher bracket. Since my income will never really go down, my taxes will only get worse.

It makes sense to boost your 401k contributions beyond the 6% if it will lower your taxable income and increase your take home pay. I had this happen when I had a large flex account. My take home pay increase about $100.

[jmjj215]

Originally Posted by CRFSaver

Good Point JMJ. I have never done the math to calculate the break even point of those scenarios. I just look at it from the point of the present value of a future dollar. The closer you get to retirement the more likely a Roth makes more sense. As I am a good 30 years from retirement those extra dollars going into my 401K make sense from my point of view.

CRF - that is a great point. A dollar of tax saved now is certainly worth more than a dollar saved 30 years from now when you begin deducting from your roth.

The problem with PV comparisons though, is that it makes the assumption that those savings dollars will be invested at your discount rate. Doing this with businesses is a bit better because you have their cost of capital (interest cost + equity cost), but with personal finance? Ick. What's your personal discount rate? Of course even if your discount rate was just 1%, you're still better off.

That being said, it's a legitimate exercise to do those comparisons personally and see what you get. Here's what a very disciplined investor might do:

You figure out what you are saving in taxes by doing the 401k instead of the roth and then you discipline yourself to actually invest that tax savings you used to determine that the 401k is better. Only then does the PV comparison hold weight!

Or you could always go throw around a frisbee or something.

[jmjj215]

To that, I hope to disqualify myself from the roth in future years by making lots and lots of money. Problem solved!

[CRFSaver]

I have been trying to disqualify myself by finding a hot girl with a trust fund but wouldnt you know they are hard to find...

[marjorie]

Ok, good advice but I another point you might want to consider. Are you planning on an early retirement? The Roth will be accessible first, and, as I understand it, you can take out money that you have contributed after 5 years. My 403b account is not set up this way. If early retirement is a goal you might want to take this into consideration. We had people at my job who retired early. Took 8 months for first pension payment to kick in, and they were all too young for social security. Those with Roths were in better stead in this situation...

[jmjj215]

Marjorie, great point that we had failed to mention.

[CRFSaver]

And if you have a 457 (government employees) you can take that out at any time with no penalties...

[BAGAGT1]

Originally Posted by marjorie

Ok, good advice but I another point you might want to consider. Are you planning on an early retirement? The Roth will be accessible first, and, as I understand it, you can take out money that you have contributed after 5 years. My 403b account is not set up this way. If early retirement is a goal you might want to take this into consideration. We had people at my job who retired early. Took 8 months for first pension payment to kick in, and they were all too young for social security. Those with Roths were in better stead in this situation...

This is one of the big selling points for me, I would love to retire early, and having some savings available if I did retire early sure would be grand.