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Is It Better To Invest In Roth Ira Or 401k

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Anthony Battle is a CERTIFIED FINANCIAL PLANNER professional. He earned the Chartered Financial Consultant® designation for advanced financial planning, the Chartered Life Underwriter® designation for advanced insurance specialization, the Accredited Financial Counselor® for Financial Counseling and both the Retirement Income Certified Professional®, and Certified Retirement Counselor designations for advance retirement planning.

Financial planners say you should aim to contribute at least 15% of your pre-tax income to retirement. But weighing exactly what kinds of accounts to put your money in, and when, can be paralyzing. Fortunately, there’s a rule of thumb for optimizing two kinds of accountsa 401 and Roth IRA or Roth 401that makes sense for most people.

In this article, we’ll dive deeper into when you should use each and how to structure your retirement contributions for maximum benefit.

Making Roth Ira Contributions

As we mentioned earlier, no matter how old you are, you can continue to contribute to your Roth IRA as long as youre earning incomewhether you receive a salary as a staff employee or 1099 income for contract work.

This provision makes Roth IRAs ideal for semi-retirees who keep working a few days a week at the old firm, or retirees who keep their hand in doing occasional consulting or freelance jobs.

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Should You Convert Your Traditional 401 To A Roth 401

The law now allows employees to convert funds from a traditional 401 plan to a Roth 401, if the plan allows it. About half of employers offer a Roth 401, according to 2017 data from Transamerica Center for Retirement Studies.

Youll have to pay taxes in the year you convert, just as you would if you converted a traditional IRA to a Roth. Plus, a large conversion could bump you into a higher tax bracket. Note that unlike converting from a traditional IRA to a Roth, you cant change your mind and undo a 401 conversion to a Roth.

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The Strengths Of A Roth Ira

The true strength of Roth IRA accounts lies in the tax benefits. Your Roth IRA contributions are based on after-tax income so they wont reduce your taxable income for the current year, but you wont pay taxes on the profit from that investment and can withdraw your money tax-free at retirementwhich means more retirement money to spend.

The Roth IRA is particularly advantageous if youre at a lower tax bracket now that you may be in the future and if your investments do as well as you hope, youll be glad that you knocked out those taxes way-back-when instead of paying on all of that profit at retirement time!

Another big benefit that makes the Roth IRA such a contender is that you can make penalty-free withdrawals of your contributions at any time.

You can also make tax-free withdrawals on your earnings under certain conditions once youve had the Roth IRA for at least five years. Those conditions include being permanently disabled, using the funds as first-time homebuyers, if withdrawals are made by your estate or beneficiary after your death, or once youve reached 59 and a half years old.

That flexibility makes it easier to bob and weave through lifes blows, but the best personal finance advice is to let your money continue to grow!

When Federal Income Tax Rates Are Favorable

Is a Roth 401k Better than a Traditional 401k?

The current tax rates, introduced with the Tax Cuts and Jobs Act of 2017, are set to expire in 2025âmeaning that they will revert to higher ratesâunless Congress extends them. Itâs anyoneâs guess what Washington will do next. What we do know, however, is that todayâs income taxes are fairly low compared with the past, and there is a lot of public spending in the pipeline that will need funding.

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Its Not Only About Taxes

Taxes are important, and they’re the primary factor in this debate. But there are other points to consider:

  • Whether youre eligible for a Roth IRA.Roth IRAs have income limits Roth 401s do not. If you earn too much to be eligible for the Roth IRA, the Roth 401 is a chance to get access to the Roths tax-free investment growth.

  • Certain income thresholds in retirement. Taking some of your retirement income from a Roth can lower your gross income in the eyes of the IRS, which may in turn lower your retirement expenses. A lower income in retirement may reduce the taxes you pay on your Social Security benefits and the cost of your Medicare premiums that are tied to income.

  • Access to your retirement money. Unfortunately, the Roth 401 doesnt have the flexibility of a Roth IRA you can’t remove contributions at any time. In fact, in some ways its less flexible than a traditional 401, due to that five-year rule: Even if you hit age 59½, your distribution wont be qualified unless youve also held the account at least five years. Thats something to keep in mind if youre getting a late start.

  • Required minimum distributions in retirement. Both accounts require account owners to begin taking distributions at age 72, but money in a Roth 401 can easily be rolled into a Roth IRA, which will then allow you to avoid those distributions and even pass that money on to heirs.

When Can I Withdraw From My Roth Ira

You can withdraw anytime from a Roth IRA, but there may be some penalties.To avoid a potential 10% early withdrawal penalty, you should withdraw after the age of 59½ or once your Roth IRA account has been open for five years. You can withdraw early and avoid penalties if you are buying a home for the first time, have college expenses to pay for, or need to cover birth or adoption expenses.

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Roth 401 Pros And Cons


  • They have a higher annual contribution limit.

  • There are no income limits.

  • Qualified distributions are not taxed.

  • Investment earnings are tax-free if taken out under a qualified distribution.

  • You must take distributions by age 72.
  • They’re only available through your employer.
  • Contributions aren’t tax deductible and won’t reduce your taxable income.
  • Early withdrawals may include a 10% penalty.

The Kind Of Roth Account That You Choose Should Depend On Several Factors

Roth IRA vs 401k (2021)

Your contributions

There is a combined cap on how much you can contribute to Roth 401 and traditional 401 accounts. Contributions to one will affect the other, but you are never ineligible because your salary is too high. Plus, the cap is several times higher than that on individual Roth IRAs. With an individual Roth IRA, you may not be eligible to make contributions in a year when your income is over the limit. If you are under the limit, you can contribute both to a Roth 401 and an individual Roth IRA.

Employer contributions

To encourage participation in company retirement plans, many employer sponsored plans match all or a percentage of employee contributions to their Roth 401s. For instance, if your employer offers a 50-percent match on anything you contribute, up to 5 percent of your salary, you will automatically see an increase in your account. Even if your employer match is subject to a vesting schedule, you should aim to contribute enough to maximize the match.

Choice of Roth investments

Often, employer-sponsored Roth 401s offer access to investment managers not available to individual investors and without the sales charges that one might incur when investing in an individual Roth IRA. Your employer, however, may limit your investment choices. If the available options wont help you reach your retirement goals, you may want to supplement your portfolio with nonqualified and individual Roth IRA savings.

Level of expenses

Accessing your account

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What Is A Roth 401k

A Roth 401k is an employer-sponsored retirement plan. But unlike a traditional 401k, contributions are made with after-tax dollars.

For context, the Roth 401k was introduced in 2006 to give Americans a new type of retirement savings vehicle to complement the popular Roth IRA, which was introduced in 1997. Roth IRAs and Roth 401ks are similar, but there are some pretty significant differences you should understand when deciding which one is right for you.

How Are They Different

Employers provide a 401 to employees as a benefit An IRA is an individual retirement account, so it belongs to you individually
Lowers your taxable income because most 401 contributions are made before taxes are taken out Your traditional IRA contributions are made from your taxable earnings, you are then permitted to deduct the contributions from your income in certain situations
The employer selects the investment options offered in the plan Typically offers a wider range of investment options than a 401
The employer may match up to a certain percentage of your contribution Isnt tied to your employer, so you dont get a match on your contributionhowever, you have more control and flexibility when and how you contribute
You may be able to roll over an old 401 from a previous job into the 401 at your current job You can roll multiple outside accounts like old 401s or other IRAs into one IRA to simplify your savings

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When A Roth May Be Right For You

Here are three situations where a Roth probably makes the most sense:

1. You are currently in a lower tax bracket, but you expect that to change. Lets say you are a young professional who is anticipating salary increases, which will put you in a higher tax bracket down the road. Contributing to a Roth IRA or Roth 401 means you pay the relatively low rate on taxable income now. Once youve retired, you will not pay any taxes on qualified distributions from the plan.

2. You are close to retirement and are concerned about RMDs. If youve been a disciplined saver and have contributed a healthy percentage of your income to Traditional accounts for many years, eventually youve got to pay the piper, says Young. Beginning in the year you reach age 72,* you must begin taking required minimum distributions from Traditional IRAs and from 401sincluding Roth 401sthe later of age 72* or once youre retired. As the name suggests, these withdrawals are required, even if you dont need the income at the time.

RMDs could bump you to a higher tax bracket. Qualified distributions from a Roth 401 or Roth IRA, on the other hand, would not create taxable income or increase your tax rate. Therefore, a Roth contribution may be preferable in order to limit the RMD income taxed at a higher rate.

– Roger Young, CFP®, Senior Retirement Insights Manager

– Roger Young, CFP®, Senior Retirement Insights Manager

If You’re Older You Can Continue To Contribute As Long As You Work

Traditional 401(k) vs. Roth IRA: Which One Wins?

As long as you have earned compensation, whether it is a regular paycheck or 1099 income for contract work, you can contribute to a Roth IRAno matter how old you are. There is no age requirement for contributions, but you must be within the income limits in order to contribute to a Roth IRA.

Learn more on Fidelity.com: IRA contribution limits

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Will The Government Get Rid Of Roth Ira

The Roth IRA program is growing rapidly and is making increasing contributions to the countrys economy. We can be sure that the government has no interest in ending the program, which is exactly what would happen if disbursements were made taxable.

Is the Roth going away?

Heres why the Democrats proposed elimination of Roth conversions for the wealthy will not begin until 2032. The House Democrats proposed a ban on converting pre-tax IRA and 401 plan funds to Roth savings for wealthy taxpayers. However, the abolition of such Roth conversions would begin after a decade, in 2032.

An Employer May Contribute

The biggest advantage to Roth 401s is the possibility for matching contributions from an employer. Employers are even offered a tax incentive to make them.

There is a hitch, though. Because employers are matching your contribution with pretax dollars, and the Roth is funded with post-tax dollars, the matching funds and their earnings will be placed in a regular 401 account. That means you will pay taxes on this moneyand on its earningsonce you start taking distributions.

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Robo Advising Roth Ira Options

If youre not comfortable making your own investments for your Roth IRA there are plenty of great options with robo-advisors. These programs help you manage your retirement funds without having to worry about researching, choosing, and potentially making the wrong investment choices.

All of these platforms do their best to minimize fees for you and provide solutions to retirement with low-cost, ETFs.

Roth 401 Vs Roth Ira: At A Glance

Roth 401k Or Traditional 401k – Which Is The Better Investment?

The term 401 refers to the tax code in which these employer-sponsored plans were created. IRA stands for independent retirement arrangement. The key difference between the Roth versions of these types of accounts and their traditional counterparts is how the tax advantages work.

  • A Roth 401 is offered by employers. Similar to a traditional 401, this type of plan is provided as a benefit. Unlike a traditional 401, the contributions you make to a Roth 401 are with after-tax dollars. Qualified withdrawals are tax free.
  • A Roth IRA isn’t tied to an employer. If you meet the eligibility requirements, you can save for retirement using a Roth IRA through a brokerage like Fidelity or Vanguard and invest after-tax dollars. Qualified withdrawals are also tax free.

“‘Roth’ means that the accounts are funded with after-tax dollars,” explains Brandon R. Amaral, a certified financial planner and founder at Amaral Financial Planning. “You don’t receive a tax deduction, however any growth in the account is tax-free.”

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Hedging Your Bets With Both

The good news is that when it comes to a traditional vs. a Roth 401, you don’t necessarily have to make an all-or-nothing choice. You may be able to have both, and decide year-by-year where you want to make your contributions.

If your employer’s plan allows it, you may even be able to split your contributions between the two types of accounts. In 2022, you can contribute a total of up to $20,500 to a 401. So, for example, depending on your plan rules, in 2022 you could decide to put $10,250 in your traditional 401 and $10,250 in your Rothenjoying the benefits of both.

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Who Is Eligible For A Roth 401

If your employer offers it, youre eligible. Unlike a Roth IRA, a Roth 401 has no income limits. Thats a fantastic feature of the Roth option! No matter how much money you earn, you can contribute to a Roth 401.

If you dont have access to a Roth option at work, you can still take advantage of the Roth benefits by working with your investment professional to open a Roth IRA.

Weighing The Pros And Cons

Whats the Difference Between a Traditional IRA and a Roth IRA?

Roth IRAs and Roth 401ks are both good options for retirement savers. The answer to which account is the better option will really depend on your unique situation. Its always a good idea to talk to your financial advisor to weigh the pros and cons and come up with what the best choice is for your situation.

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Roth Retirement Accounts Offer More Options

Why does Orman like Roth retirement accounts so much more? Because they offer more flexibility than a traditional 401. With a Roth 401, you don’t ever have to take the required minimum distributions. Meanwhile, a traditional retirement account requires you to start taking money out at age 72. If you miss this deadline, or don’t take enough money out, the penalty can be severe: The amount not withdrawn is taxed at 50% rate.

Meanwhile, if you’re planning to leave retirement savings as an inheritance, Orman says a Roth 401 is better here, too. What if your kids are in a higher tax bracket than you ever were in, and you leave them money in a traditional 401?

They’re going to lose a lot of that money, Orman says. But with a Roth, they get it without income taxes, she says.

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