Terry Mitchell

A Roth IRA vs. a 401(k)



Posted: Thursday, December 17, 2009

by Terry Mitchell
http://commenterry.blogs.com

Even in times of economic turmoil, one of the most important financial objectives for individuals of working age is to save for retirement.  It is important to secure your future financially by ensuring that you will have enough money saved up for you to enjoy the lifestyle you desire in retirement. 
 
There are several ways to plan for and save for your golden years.  The two most popular retirement savings vehicles are the Roth IRA and the 401(k).  Below is a simple comparison of the two.
The Roth IRA

A Roth IRA is an Individual Retirement Account that allows for tax benefits under U.S. law.  With this type of retirement savings account you pay tax only once instead of twice.  You contribute post income-tax dollars to your Roth IRA, and then your principal grows tax-free.  You then pay no further taxes upon withdrawal.  This is a huge benefit if you expect that taxes will rise in the future.  Another benefit the of the Roth IRA is that your dependents will be able to withdraw money from the account without having to pay taxes in the event of your death.

The 401(k)

The 401(k) is an employer-sponsored, tax-sheltered retirement savings plan.  Instead of contributing post-tax dollars to a 401(k), you contribute (and earn interest on) pre-tax dollars.  Taxes on your principal and interest earnings are paid to the IRS upon withdrawal at retirement.  Many employers that offer a 401(k) plan as a benefit to their employees also offer some sort of "matching."  That is, for every dollar you contribute to your 401(k), your employer will match a certain percentage of it (up to 100%) until a limit set by the employer is reached.

Similarities

Both Roth IRA's and 401(k) accounts carry strict rules about contribution eligibility, limits, and holding periods.  You must make sure you understand the rules of the specific account you are dealing with. as mistakes can prove to be quite costly.

Differences

The main difference between the 401(k) and the Roth IRA is when they are taxed.  As aforementioned, a 401(k) is taxed upon withdrawal so that the principal you contribute is allowed to earn tax-free interest until retirement.  By contrast, a Roth IRA is simply not taxed as the contributions you make are with dollars you have already paid income tax on.  The other difference is the possibility that your employer may offer fund matching on their qualified 401(k) plan.   Check with your human resources department for specific details about your employer's plan.

The Verdict

Choosing between a Roth IRA and 401(k) can be difficult.  The chief factor in determining which will be better for you has to do with your expected future tax rate will be.  If you expect it to roughly stay the same, a 401(k) is the better bet.  If you expect your tax rate to rise considerably, a Roth IRA will leave you with more funds. The best strategy is to contribute to your 401(k) in order to get the maximum fund matching from your employer, and then also open a Roth IRA.


Terry Mitchell is a software engineer, freelance writer, amateur political analyst, and blogger from Virginia, USA. He posts a least one article a day to his blog - http://commenterry.blogs.com - on subjects such as current events, politics, technology, society and culture, religion, health and well-being, self improvement, personal finance, trivia, and sports.

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