roth 401k vs tradtional IRA vs Roth IRA

[thomasdan]

hello everyone!!!!!


Right now I invest 10% of my paycheck to 401k.

My cousin mention to me about IRA

IVe tried reading up on it and to be honest, its just confusing to me.

Can someone break it down for an average joe that could understand.

What is the best option? i know everything has pros and cons.

is IRA something that makes more money when the market is doing good? or does it only increase when adding funds kinda like a savings account?

please help. Thanks

[bUU]

Some things really cannot be simplified. There are a number of factors and different situations will lead to different conclusions. If one was better than the other at all times, then there wouldn't be a need for the other choices.

To answer this question, however, we'll need to know whether or not you're eligible to deduct contributions to tIRAs, and whether or not you're eligible to make Roth IRA contributions. Those are based on your income.

[Petunia 100]

An IRA is a type of account. You choose what goes inside the account. You open the account with the custodian of your choice: a bank, a brokerage firm, a mutual fund family, or an insurance company (but PLEASE, don't choose an insurance company). You choose what goes into the IRA: passbook savings account, CDs, stocks, bonds, mutual funds, ETFs.

How well or how poorly your IRA performs depends upon the performance of the investments you choose.

There are two types of IRAs: traditional and Roth. A traditional works much the same as your traditional 401k, except that you may not be able to deduct your contributions, depending upon your income. A Roth IRA works a bit differently. You receive no upfront tax benefit; if you follow the rules, later you can withdraw your money and your earnings tax-free.

Also, IRAs are not funded directly from your paycheck. Instead, you will mail a check or set up direct transfers from your checking account.

Does that answer all of your questions?

[disneysteve]

To elaborate:

A 401k is an employer-sponsored plan. It is funded by payroll deduction. Money goes in pre-tax, grows tax-free, and is taxed upon withdrawal in retirement. You must be at least 59-1/2 to withdraw the money without penalty. Not all employers offer these plans. In fact, I believe only about half of American workers are covered by a 401k plan.

A Roth IRA is a personal retirement account that you open, fund, and control. There are income restrictions governing who can contribute to a Roth so not everyone is eligible for this either, but many more people are.

You can have both a 401k and a Roth as long as you meet the income requirements.

Commonly, employers provide some type of match to your 401k contributions, often 50 cents on the dollar up to a certain percentage of your income.

The prevailing advice is generally to contribute to a 401k to the point that you get the full company match, then fund a Roth to the maximum amount ($5,500 if you are under age 50), then go back to the 401k for any additional savings that year.

[smk]

as suggested above iras are nothing but accounts with tax benefits (much like a 401k) that house various instruments that you can hold in a regular account.

generally, the decision between trad ira vs roth ira entails a bet on tax rates. if your tax rates are expected to go up or stay the same, roth is more likely to be better. if you expect your tax rates to go down or be volatile with some bad years, the trad ira is better. then you convert to roth when your tax rates are low.

you need to make a decision of whether it is best to put stocks vs bonds in the accounts as well. the formulas for all these decisions requires 7th or 8th grade math. it is not difficult. let me know if you need them.

[Petunia 100]

as suggested above iras are nothing but accounts with tax benefits (much like a 401k) that house various instruments that you can hold in a regular account.

generally, the decision between trad ira vs roth ira entails a bet on tax rates. if your tax rates are expected to go up or stay the same, roth is more likely to be better. if you expect your tax rates to go down or be volatile with some bad years, the trad ira is better. then you convert to roth when your tax rates are low.

you need to make a decision of whether it is best to put stocks vs bonds in the accounts as well. the formulas for all these decisions requires 7th or 8th grade math. it is not difficult. let me know if you need them.

Don't you need to advise DisneySteve that standard rules of thumb are "irresponsible"?

[disneysteve]

Don't you need to advise DisneySteve that standard rules of thumb are "irresponsible"?

I don't think rules of thumb are irresponsible. I think rules of thumb are starting points. They shouldn't be followed blindly. Everyone's circumstances are unique in some regard and need to be taken into account but when you are starting from scratch, the rules of thumb are a good place to begin your evaluation and then customize a plan that makes sense for your particular situation.

[Petunia 100]

I don't think rules of thumb are irresponsible. I think rules of thumb are starting points. They shouldn't be followed blindly. Everyone's circumstances are unique in some regard and need to be taken into account but when you are starting from scratch, the rules of thumb are a good place to begin your evaluation and then customize a plan that makes sense for your particular situation.

Oh, I agree with you completely, DisneySteve. I am referring to a thread on the "Investing & Banking" forum, started by a new member named Beegee, in which Smk has spent the last several days taking great exception to the very sound rule of thumb you shared here.

[smk]

I don't think rules of thumb are irresponsible. I think rules of thumb are starting points. They shouldn't be followed blindly. Everyone's circumstances are unique in some regard and need to be taken into account but when you are starting from scratch, the rules of thumb are a good place to begin your evaluation and then customize a plan that makes sense for your particular situation.

first, when you quote a rule of thumb for someone, do you also tell them it shouldn't be followed blindly and their individual circumstances should be considered before you make your final decision? if not, how are they supposed to know?

second point is a simple question of logic. you tell people the rule of thumb is to maximize your roth before your trad ira, but don't actually do so until you take your individual circumstances into account. based upon your circumstances, you may lay out a completely different course of action because there is a specific reason it is more likely to the help you achieve your objective than the rule of thumb. you never explained the reasons for the rule of thumb, so there was no educational benefit. so what was the point of telling them the rule of thumb?

[thomasdan]

im not sure what you guys are talking about since my knowledge in this field is lacking a bit.

but, i opened up a roth ira last night and putin 100 dollars. woohoo.on my way to retirement. lol

what is my next step going foward to build wealth. i know the goal is to maximize it. but what next?

[Petunia 100]

im not sure what you guys are talking about since my knowledge in this field is lacking a bit.

but, i opened up a roth ira last night and putin 100 dollars. woohoo.on my way to retirement. lol

what is my next step going foward to build wealth. i know the goal is to maximize it. but what next?

That's awesome, Thomasdan! Congrats.

Although it has only been mentioned indirectly, one thing you want to keep a close eye on is fees. Every investment fee you pay compounds against you. Over the years, excessive fees will take a huge bite out of your retirement nest egg.

And of course, you want to choose investments which are appropriate for your goals. When one is just getting started, a sound strategy is to choose a target retirement fund, a lifecycle fund, or some other balanced fund. Such a fund will give you exposure to US stocks, foreign stocks, and bonds with your very first $100.

May I ask what investment you chose and which custodian you chose?

I apologize for interrupting your thread with my comment to Smk. It wasn't at all relevant, please just ignore it.

[disneysteve]

i opened up a roth ira last night and putin 100 dollars.

Congrats. That's a big first step. I'm also curious where you opened the account. The options with $100 are somewhat limited. Also, what investment did you choose for that money?

[thomasdan]

i went with FIDELITY

the only reason i went with them is they're hosting my 401k through my employer.

is that a smart move? or should you do a roth with a different company?

i copy and paste the 2 option they gave me when i was registering.

i chose teh Fidelity Government Money market fund (SPAXX).

Can someone explain the difference between the 2?




Core Position
Your core position is where the money in your account is held until you invest it. Select one of the options below. Once your account is open, you may have additional core positions available. As always, you can change your core position at any time by calling a Fidelity Representative.


Fidelity Government Money Market Fund (SPAXX)
A money market mutual fund (not FDIC-insured). Prospectus
Opens in a new window.


FDIC Insured Deposit Sweep Program
An interest bearing position that is eligible for FDIC insurance. More Information
Opens in a new window.

[bUU]

i went with FIDELITY
the only reason i went with them is they're hosting my 401k through my employer. is that a smart move?

It is not a good enough reason on its own, but Fidelity happens to be one of those choices that would be a good choice regardless, and the fact that they are the custodian of your 401k gives them an advantage over the other two choices that typically are found at the top of such lists.

i chose teh Fidelity Government Money market fund (SPAXX).
Can someone explain the difference between the 2?

This shouldn't matter specifically because you should generally keep very little in your core position. Therefore, whether the core position has FDIC insurance or not doesn't really matter. I don't remember why, but we chose SPAXX as well.

Note that we chose the FDIC option for our Fidelity Cash Management Account. That's not being used as a brokerage account.

[smk]

im not sure what you guys are talking about since my knowledge in this field is lacking a bit.

but, i opened up a roth ira last night and putin 100 dollars. woohoo.on my way to retirement. lol

what is my next step going foward to build wealth. i know the goal is to maximize it. but what next?

what we were talking about is that while it is always good to save, no one on this thread has the slightest idea whether you should put the money in a roth or trad ira. when they told you the roth was better, they really didn't know.

if you think your tax rate is high and will probably be low later on, better to open a trad ira and fund that one going forward. when your tax rates do fall either due to a bad year or in retirement, then convert it to a roth.

you also might need to get better grounded before you start investing the funds in bonds, stocks or mutual funds. always good to know what you are buying before you buy it...the goal is not to maximize wealth, but to make sure you can pay your bills in retirement. mathematically, these are 2 different problems with 2 different solutions.