Where is your retirement money?

[disneysteve]

Is there a benefit to having both an IRA and a 401k? Or do you invest in both if you're unhappy with your 401k options?

Yes and yes.

Roth IRAs have a number of benefits over 401k plans. You have a much broader, virtually unlimited, range of investment options. The money goes in after-tax and then is tax-free when withdrawn. There is no age at which you must take withdrawals so you don't have to touch that money until you need it. While I don't advise this, your contributions to a Roth can be withdrawn at any time for any reason at no cost or penalty.

The advice you will generally hear is to contribute to the 401k to get the full company match. Then max out your Roth. Then go back to funding the 401k to the extent that you are able.

[Beccagold]

Yes and yes.

Roth IRAs have a number of benefits over 401k plans. You have a much broader, virtually unlimited, range of investment options. The money goes in after-tax and then is tax-free when withdrawn. There is no age at which you must take withdrawals so you don't have to touch that money until you need it. While I don't advise this, your contributions to a Roth can be withdrawn at any time for any reason at no cost or penalty.

The advice you will generally hear is to contribute to the 401k to get the full company match. Then max out your Roth. Then go back to funding the 401k to the extent that you are able.

Thanks Steve! Does this only apply to Roths? If you don't qualify for a Roth is there any benefit to doing both a 401k & a regular IRA?

[disneysteve]

Thanks Steve! Does this only apply to Roths? If you don't qualify for a Roth is there any benefit to doing both a 401k & a regular IRA?

You wouldn't have most of those advantages. You would still have the unlimited investment options, but not the tax-free withdrawals. You couldn't take the money out penalty-free. You would have to take required distributions starting when you are 70-1/2.

I'm not positive, but I think if you can't do the Roth, it makes more sense to just use the 401k. If anyone thinks otherwise, please chime in.

[jIM_Ohio]

Thanks Steve! Does this only apply to Roths? If you don't qualify for a Roth is there any benefit to doing both a 401k & a regular IRA?

You wouldn't have most of those advantages. You would still have the unlimited investment options, but not the tax-free withdrawals. You couldn't take the money out penalty-free. You would have to take required distributions starting when you are 70-1/2.

I'm not positive, but I think if you can't do the Roth, it makes more sense to just use the 401k. If anyone thinks otherwise, please chime in.

There are ways to make any combination work (401k+traditional, 401k+roth, 401k+taxable account). I would say a traditional IRA makes sense for someone young, where a taxable investment makes sense for someone closer to retirement. The assumption made is a person will invest the same amount, regardless of tax bracket, trying to find a way to make maximum amount work for the person while paying the least amount of taxes over a period of 5-10-15 years. My opinion is that a person's tax status changes little after age 70.5. Most tax planning needs to happen before that age.

I like 401ks because it lowers current taxes. While many people believe tax rates will go up, that is a problem to solve later. This strategy (pay taxes later) has been working for accountants for years.

75% of the people in this country have their top income in the 10 or 15% tax brackets. That means a max taxable income of 66k for 2007.

My comment would be lower current taxes paid is money in your pocket now.

So comment 1 is if 401k has good choices, use that to it's max. Get the match and then some. $15,500 below age 50 and $20,500 above age 50.

comment 2 is a Roth IRA. It makes sense if a person is in 15% tax bracket to use the Roth in some ways (pay cheap 15% taxes now). If a person is in 25% tax bracket there are many many other techniques which should be considered before going with blanket advice "max out the Roth". 25% bracket and higher (taxable income above 66k), I would recomend 401k with good choices over a Roth with some exceptions and deviations. Do not accept "if eligible for Roth, use it" blanket advice.

comment 1 and 2 combined would be:
1) contribute 401k to match
then
if in 15% bracket, contribute to a Roth
if in 25% bracket, contribute to 401k (to get into 15% bracket if possible)
if in 28% tax bracket, Roth is probably off the table, so increase 401k and/or use other investment methods. If in 28% bracket and planning puts you in 25% bracket, Roth makes sense (if withdraws in retirement put you back into 28% bracket). More than likely if you go to level of planning to drop from 28% bracket to 25% bracket, the 401k withdraws will be back in 28% bracket or higher.

After looking at tax rates, a person in 25% bracket should ask- can they get into 15% bracket with some tax planning? Then once in the 15% bracket, do some other tax planning to pay more taxes (at 15% level) and avoid paying them at 25% level. This level of planning is the same as getting a 10% return on investment, so this could be $6600 plus in someone's pocket each year if they make $66000.

Tax planning:
maxing out 401k is first place I would look
Mortgage interest deduction and property taxes are second place to look

these are the two most common ways to reduce taxes now.
Other ways- Use an HSA to defer taxes on health care costs.
Small business write offs- open a small business to write off little things here and there which really add up.

Then use a traditional IRA which may or may not get converted into a Roth. If closer to retirement (within 10 years), I strongly recomend avoiding a deposit which will be withdraw within 10 years, unless tax brackets for you are going to change drastically in retirement. Even with a drastic change, I think taxable account wins out in most 10-15 year scenarios.

If a person can do some long term tax and investment planning, it's possible their situation will look like this:

ages 18-x earn in 25% or 28% tax bracket. At these levels defer taxes into the future as much as possible. If in 15% bracket get money into Roth's. 401k+traditional IRA makes sense. 401k+taxable account also makes sense. Accumulation of money is goal, with small eye towards withdraw phase. As withdraw phase gets closer, having money in taxable accounts will provide flexibility.
ages x+1 retire (before age 70.5)
between ages x+1 and 70.5, many people will find themselves in a lower tax bracket- simply because things like FICA and medicare are no longer taken from paychecks, and retiring early meant the person set a good chunk of income aside anyways. Before age 70.5 there are no RMD's, so 401ks and traditional IRAs can be converted to Roth. Taxable accounts can help accelerate this. My suggestion is to cap out 15% bracket with Roth conversions. If you need 40k to live on, 15% bracket caps at 66k, so convert 22k to the Roth, paying 15% taxes on the conversion. You could withdraw 40k from a taxable account and convert 66k to a Roth if you have the taxable account to withdraw from (and that would be taxed at only 5%).
At age 70.5 RMDs kick in (Required minimum distributions). This means the government is requiring you to withdraw from your 401k and traditional IRA, taxing you at whatever marginal bracket the RMD and other income put you in. You could still take out more than the RMD. If the RMD is in 15% tax bracket, the suggestion is to keep capping out 15% tax bracket with Roth conversions, until point where all money is in Roths and no taxes are due on withdraws.