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Dear Dr. Don,
I am 24 and put 10 percent of my income into my 401(k). If my company does not match my 401(k) contribution, am I better off contributing that money to a Roth IRA?
-- Regina Retirement
Dear Regina,
Your ability to contribute to a Roth IRA account
in 2008 is determined by your income. Here's what
IRS Publication 590, "Individual
Retirement Arrangements," says about the income
restrictions: (in the following example, "-0-"
is equivalent to "zero dollars.")
For 2008, your Roth IRA
contribution limit is reduced (phased out) in
the following situations:
- Your filing status is married filing jointly
or qualifying widow(er) and your modified
AGI (adjusted gross income) is at least $159,000.
You cannot make a Roth IRA contribution if
your modified AGI is $169,000 or more.
- Your filing status is single, head of household,
or married filing separately and you did not
live with your spouse at any time in 2008
and your modified AGI is at least $101,000.
You cannot make a Roth IRA contribution if
your modified AGI is $116,000 or more.
- Your filing status is married filing separately, you lived with your spouse at any time during the year, and your modified AGI is more than -0-. You cannot make a Roth IRA contribution if your modified AGI is $10,000 or more.
The modified AGI, or MAGI, limits for the 2009 tax year will be a few thousand dollars higher than the 2008 numbers. The publication "IRS Announces Pension Plan Limitations for 2009" puts a finer point on it if you're bumping up against these MAGI limits.
Assuming you're eligible to contribute
to a Roth IRA, you still have to decide if it
is the better choice. Both the Roth IRA and the
401(k) plan are tax-advantaged accounts. With
the Roth, you contribute after-tax dollars today,
and qualified distributions coming out of the
account aren't subject to federal income taxes.
With a 401(k) plan, you contribute
pretax dollars today, and qualified distributions
are subject to federal income tax at your ordinary
income rate. Being able to borrow money from the
plan is an advantage to a 401(k) versus a Roth
IRA, but the loan has to be repaid if you leave
your company. Otherwise, it is counted as a distribution
from the plan and is subject to income tax and
possibly a penalty tax if it is an early distribution.
While there is no loan program available for a Roth IRA account, you contributed after-tax dollars, so no income tax is due on withdrawals of your contributions. You can withdraw your original contributions for any reason and at any time without taxes or penalties.
However, early distribution of investment
earnings can be subject to income taxes and
may be subject to a 10 percent penalty tax. The
age of the account matters. Distributions from
accounts less than five years old are treated
differently than accounts more than five years
old. In addition, different tax rules
apply if the money is withdrawn early (before
age 59½) for certain reasons, such as to pay for
qualified education expenses or to buy a home
for the first time, or if the account holder has
died or is disabled. When in doubt about the rules,
work with your tax professional.
Most people in their 20s are in
a lower marginal federal income tax bracket than
they will be when they retire. If you expect that
your tax rate is lower today than it will be when
you retire, contributing to a Roth IRA can make
sense versus contributing to a 401(k) plan. The
Bankrate article "Traditional
IRA vs. Roth IRA" can help you make the right
decision.
Another advantage to the Roth IRA account is that you can control where the account is held. Being able to do this lets you have some control over account fees and expenses and lets you pick a custodian that offers the types of investments you want for the account.
A lot of workers complain about
the investment choices offered in their employer's
401(k) plans. You can finesse these issues by
picking your custodian based on how you want the
money invested.
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