Retirement: 401(k) Vs. Roth IRA – Which is best for Me?
Retirement: 401(k) Vs. Roth IRA – Which is best for Me?
Any money manager will admit that one of the most frequently asked questions among their clients is whether a 401(k) or Roth IRA is the best for retirement. The answer is a bit complex and can be different for each individual client. Let’s take a look at both the 401(k) and Roth IRAs and the benefits that each have to offer.
What You Need to Know About 401K and Roth IRA Plans
A 401(k) is an employer sponsored retirement plan that is governed under section 401(k) of the Internal Revenue Service code. Basically, a 401(k) plan is structured so that you sign up for the plan with your employer and choose from various investment options within the offered plan. Your employer will take money out of your paycheck on a pre-tax basis (a big plus for now, but you will pay taxes on this money when it’s withdrawn later on) and deposit this money into your plan. Many employers offer matching contributions – often dollar per dollar. When you reach retirement age, you can withdraw money from your 401(k). The 401(k) contribution cap has been raised for 2009, and is $16,500 for persons 50 and under and $22,000 for those over fifty. There are no income limits for 401(k) participants.
A Roth IRA is an individual retirement account that is set up by an independent investment firm or money manager on your behalf. With a Roth IRA, you set up an account with an investment firm yourself as opposed to going with whatever investments your employer offers. You deposit after-tax earnings into your Roth IRA account and the money manager uses their expertise to invest the money for you. Most Roth IRAs can be drawn on after you have reached 59 ½ years of age and have had the plan for at least five years. The Roth IRA contribution cap is $5,000 per year for those under 50 years of age, and $6,000 for those fifty and over. There are income limitations that apply to participants in the Roth IRA, and those who earn more than $120,000 as an individual or $176,000 jointly do not qualify to contribute.
Differences between 401(k) and Roth IRA
There are distinct differences between these retirement options, mainly employer contributions, investment options, and tax implications. With a 401(k) your contributions are often matched by your employer; Roth IRAs are independently managed and not related to your place of employment. This is a big selling point for the 401(k) – and it is hard to turn down this “free” money from your employer. However, with a 401(k) plan, you are limited to the investment options that your employer chooses to offer; Roth IRAs give you the freedom to choose a money manager and the investments that interest you. A 401(k) plan allows you to contribute (temporarily) tax free money towards your retirement, but you pay for that luxury in the long run, especially if your income tax rate is higher when you elect to withdraw your money from the plan. Younger investors are usually particularly concerned with predicting what their tax rate will look like and with good reason – they don’t want to give up a big chunk of their 401(k) proceeds to Uncle Sam.
Which is Better?
Again, that depends on a number of factors. If you are young, the Roth IRA may provide a more sensible approach, especially if you find a talented money manager who will invest wisely on your behalf. Older individuals who are near retirement may be better off with a 401(k) plan. Determining the best option for your retirement goals is best addressed with a personal consultation with a money manager. Visit www.moneymanager.com to find a money manager in your area who can help you mold a plan for your future.
