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Dear Dr. Don,
I’m investing in my employer’s 401(k) plan, despite the fact that the company doesn’t offer matching contributions. Should I continue to invest in the 401(k) or switch to a Roth individual retirement account? I’m 25 years old and have about $12,000 invested.

Thanks,
— Richard Retirement

Dear Richard,
The questions associated with funding a Roth IRA or a 401(k) involve more than just whether you get matching contributions. One key issue is the timing of income tax liability. Does it make more sense to invest your after-tax money in a Roth IRA, or is it better to go with a tax-deferred option, like a traditional IRA or 401(k) plan?

Variables such as fees, expenses and investment options are also important. You generally have more investment options and lower fees and expenses in a Roth IRA than in a 401(k) plan. Your company’s 401(k) plan will let you contribute more than the annual contribution limits governing an IRA.

Because your employer offers a 401(k) plan at work, tax-deferred contributions to a traditional IRA are linked to your modified adjusted gross income, or MAGI. Your ability to contribute to a Roth IRA is also phased out at higher income levels. But even if you are restrained by income limitations, you can always fund a traditional IRA with after-tax dollars and later convert to a Roth IRA.

IRA calculators, such as those provided by Bankrate, can help you decide whether to make after-tax contributions to a Roth IRA or tax-deferred contributions to a 401(k) or traditional IRA. At issue is the tax rate you’re facing at this point in your life versus what you expect in retirement. People just beginning their careers are often in lower tax brackets than in their retirement years. That suggests the Roth IRA will be the better choice.

Bankrate’s “Roth vs. traditional IRA” calculator can help you know the difference between the expected after-tax and tax-free numbers. The calculator assumes that you invest the tax savings derived from tax-deductible contributions. That’s with the goal of making it the proverbial “apples to apples” comparison with the Roth IRA.

For example, if you’re in the 20 percent tax bracket, contributing $5,000 to a Roth IRA costs $5,000 and you will owe $1,000 in federal income taxes. If you contribute $5,000 to the 401(k), the money goes in before taxes. So you’re contributing $5,000 and you cut your tax bill by $1,000 for the year. The 401(k) option assumes you invest the tax savings.

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