retirement

Choosing between 401(k) and Roth IRA

Don TaylorQuestionDear Dr. Don,
Please recommend how much to allocate retirement savings between a 401(k) plan and a Roth IRA. How do I choose between the two, assuming there is no employer match in the 401(k) plan?
-- Arul Assigns

AnswerDear Arul,
With no employer match, your choice is similar to the decision between a traditional IRA and a Roth IRA -- at least up to the contribution limits of an IRA account. In general, you want to contribute on a tax-deferred basis if you expect your marginal federal income tax rate to be lower in retirement than it is today. If you're in a fairly low bracket now, then making after-tax contributions to a Roth IRA allows you to take qualified tax-free distributions in retirement.

Another reason to contribute to the Roth IRA is if you don't expect to need the money in retirement because Roth IRAs aren't subject to required minimum distributions.

Employee contributions to a 401(k) plan are made with pretax dollars. Contributions to a Roth IRA are made with after-tax dollars. To put the contributions on an apples-to-apples basis, you need to invest the tax savings benefit from contributing to the 401(k) plan. Said another way, if it costs $8,000 in gross salary to contribute $6,000 to a Roth IRA, you'd want to compare that investment with a $6,000 contribution to your 401(k) plan that resulted in a $1,500 reduction in your federal income taxes due for the year. You would invest the $1,500 tax savings for retirement. (I assumed a 25 percent marginal federal income tax bracket and no state income taxes.)

The article in the Bankrate Tax Guide, "Retirement plan contribution limits," illustrates that the contribution limits differ greatly between an IRA account and a 401(k) plan. If you decide that the Roth IRA is your first choice for funding retirement savings, you may still want to contribute to your company's 401(k) plan, too.

While there are income limits on contributing to a Roth IRA, you have the ability to contribute after-tax dollars to a traditional IRA and then convert it to a Roth IRA. Talk to your tax professional if you're uncertain about this process. IRS Tax Topic 309, Roth IRA Contributions, provides additional information.

Get more news, money-saving tips and expert advice by signing up for a free Bankrate newsletter.

Ask the adviser

To ask a question of Dr. Don, go to the "Ask the Experts" page and select one of these topics: "Financing a home," "Saving & Investing" or "Money." Read more Dr. Don columns for additional personal finance advice.
 

Bankrate's content, including the guidance of its advice-and-expert columns and this website, is intended only to assist you with financial decisions. The content is broad in scope and does not consider your personal financial situation. Bankrate recommends that you seek the advice of advisers who are fully aware of your individual circumstances before making any final decisions or implementing any financial strategy. Please remember that your use of this website is governed by Bankrate's Terms of Use.

News alert Create a news alert for "retirement"

advertisement

Show Bankrate's community sharing policy
          Connect with us
advertisement
CD & INVESTING NEWSLETTER

Learn the latest trends that will help grow your portfolio, plus tips on investing strategies. Delivered weekly.

Blog

Jennie Phipps

Get your shots and stay healthy

Vaccinations are free for Medicare participants and people insured under the ACA.  ... Read more

advertisement
Partner Center
advertisement

Connect with us