401k or Roth IRA?

athomas2424 · January 2014

I'm confused as to if it would be beneficial to contribute to a Roth IRA in addition to my 401k that I currently have.

I've researched it and it appears one of the main reasons one would do a Roth IRA as well is because you pay the taxes now, not later, and your tax rate may be lower now than it is later.

But the way I am looking at it is that I do not plan to withdraw anything from my 401k until full retirement age so I would think my 401k withdrawals at that time should not be taxed at my current rate (I think I'm at 28%) because I will not be working at retirement time so I won't have an income.

I could be overthinking this! I have the option through work to contribute to 401k and Roth IRA. Right now I have all 15% going into my 401k.

hoffse · January 2014

Hi OP. A few things:

1) Tax rates change annually - and I personally think marginal rates will only go up.

2) You will have an income in retirement - any withdrawals from your 401(k) will be included on your tax return as income, and it will be taxed as ordinary income. At a certain age (70 1/2), you also have to start withdrawing a particular percentage each year or else face a huge penalty. Things like social security and pensions are also taxable. For most people, this results in higher taxes during retirement than when you're young.

3) The reason Roths are great - assuming the law doesn't change - is that you can withdraw both the contributions AND the gain tax-free in retirement. When invested in the market, money doubles, on average, every 7 years. So that's beyond huge. In a regular 401(k) you will be taxed on your original contributions, and any gain you earn. Again, this will be taxed at ordinary income rates. The taxes on regular 401(k)s are actually higher than if you had just put the money into regular investment accounts... because gains in regular investment accounts are taxed at capital gains rates (15%) instead of ordinary income rates (25-28% for most people). Plus, your contributions are not taxed in regular investment accounts... since they are funded with after-tax money.

4) All that said, you want to get an employer match if its offered. So if you employer matches part of your 401(k) contribution, do that first. An employer match is taxable, but it's also free money. Then max out the Roth IRA before putting whatever is left back in the 401(k).

5) Many employers are now offering Roth 401(k)s. These work exactly like Roth IRAs, except the contribution limits are higher. IRA contribution limits are $5500/year and 401(k) contribution limits are $17,500/year. I do think that if the laws on Roth accounts change, the 401(k)s will be the first to go... Congress stands to lose a lot more on Roth 401(k)s than on Roth IRAs. But, if it's available to you and you can afford to at least partially fund a Roth 401(k), it might be worth starting.

Wulfgar · January 2014

I agree with Hoffse, marginal taxes in the future will go up until the baby boomers start dying off in large numbers. You have to remember that marginal tax rates are at their lowest in a long while and just like interest rates, there is only one way to go, up.

athomas2424 · January 2014

Oh wow, ok that really put things into perspective for me!!! Also kinda bummed out by realizing that even though we will have a large 401k balance, that number really isn't quite as pleasing as I originally thought after taxes :-(

I adjusted my contributions this morning to 10% 401k and 5% ROTH since those are my 2 options my work offers and I'll still get the full employer match that way. It may even make more sense to swap those percentages, even though its hard to see it that way since the 401k balance is a lot bigger so it would seem to grow a lot more over the years even though its eventually taxed more. I will check out how that affects my paycheck first then may increase the ROTH from there if my gross stays about the same!

Thanks as always hoffse and thank you wulfgar!

401k or Roth IRA?

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