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Discussion Starter · #1 ·
Something is not clicking for me about this concept. I have read many places that you should invest in a 401K up to the point where your employer's match is maxed. After that, you should invest in a Roth IRA. Is it because you have more choice of investments with a Roth? Isn't there a tax benefit to maxing out your 401K contribution (beyond the employer match)-your wage is lower and therefore your taxes are lower? I know there must be a good reason so many people advise the IRA and I'm just not getting it.<br>
x<br>
Help!<br><br>
Lisa
 

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woops<br><br>
Liz
 

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Which is better depends on the tax bracket you're in. I invest in my 401(k) for the full tax deduction because I need it now. I also put money in a Roth.
 

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<div>Originally Posted by <strong>lisalulu</strong> <a href="/community/forum/post/6493867"><img alt="View Post" class="inlineimg" src="/community/img/forum/go_quote.gif" style="border:0px solid;"></a></div>
<div style="font-style:italic;">Something is not clicking for me about this concept. I have read many places that you should invest in a 401K up to the point where your employer's match is maxed. After that, you should invest in a Roth IRA. Is it because you have more choice of investments with a Roth? Isn't there a tax benefit to maxing out your 401K contribution (beyond the employer match)-your wage is lower and therefore your taxes are lower? I know there must be a good reason so many people advise the IRA and I'm just not getting it.</div>
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You may be able to find a calculator on the internet that will tell you which would (probably) be better in your situation. The main advantage of contributing to the 401(k) is that you can invest more actual dollars for the same net impact on your current bottom line -- so, for example, if 30% of your income goes to taxes, you can invest $1000 in a 401(k) plan for the same net change in your paycheck as investing $700 in a Roth IRA.<br><br>
Of course, you then have to figure out whether you think the taxes you'll eventually pay on the money in the 401(k) would be greater than the difference in the eventual investment value due to the reduction in the initial investment in the Roth IRA.
 

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The other benefit of a Roth IRA is that it is funded with after tax money and when you withdrawl the money after you are 59 1/2 years old the money is yours TAX FREE. The money in your 401K will be taxed at the current tax bracket.<br><br>
My financial planner recommends that you contribute to your employer's 401K until you reach the full matching, then max out a Roth IRA and if you have money leftover then put it back in your 401 K plan.
 

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The main advantage of a 401(k) above the matching employer dollars is that it is pre-tax dollars, which means that you are accruing compound interest on the tax you would have to pay. With a Roth, you pay taxes now, so you don't get to earn interest on the tax dollars you would have paid.<br><br>
So, let's say you would pay $1,000 in taxes. Instead, you invest in your 401(k) and get to put that $1,000 in your account and accrue interest on it. In 30 years, that $1,000 would gain you $17,500 more (at 10%). THEN you pay taxes on the money.<br><br>
If you have a 401(k) plan with good investing options, it is ALWAYS better to save in your 401(k). If the plan has poor options, it might be prudent to investigate an IRA.<br><br>
A few points to note:<br><br>
Many people do not qualify for the tax deduction of a traditional IRA.<br><br>
With a Roth IRA, you do not pay taxes when you take distributions, you do pay taxes when you take distributions with a Traditional IRA.<br><br>
With a Roth IRA, you can take withdrawals without penalties.<br><br>
With a Traditional IRA, you will be taxed and penalized for early withdrawals (before you are 59.5 years old).<br><br>
Both Roth and Traditionals can be inherited by your beneficiaries without having to cash them out. That means that they can continue to accrue interest for your kids.
 

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yup what people said....if your 401k gets dollar for dollar match.... definitely get that since its free money...and then start putting it in your roth ira because that money is taxed first...and not taxed later (its more $$$ than your 401k)
 

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<div>Originally Posted by <strong>Godaime</strong> <a href="/community/forum/post/6496955"><img alt="View Post" class="inlineimg" src="/community/img/forum/go_quote.gif" style="border:0px solid;"></a></div>
<div style="font-style:italic;">yup what people said....if your 401k gets dollar for dollar match.... definitely get that since its free money...and then start putting it in your roth ira because that money is taxed first...and not taxed later (its more $$$ than your 401k)</div>
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That's not what I said! I didn't agree with other people.<br><br>
If you have a 401(k) that has good, sound investment options it is better to invest in your 401(k) BECAUSE you get taxed later. The advantage of that is that instead of paying the tax money to uncle sam, you get to invest it for yourself and MAKE MONEY off of that tax money. It's simple math... if you can either pay $1000 in taxes now, or pay $2000 in taxes later, but be ahead by $15,000, wouldn't you rather do that?<br><br>
Your first reaction may be, well if I wait to pay the tax man in 30 years, I'm going to end up paying a lot more in taxes that I would now. That's true, and that's the way the gov't wants you to think. They want the tax money now, too. That's why they created the Roth IRA. But if you can be ahead by 10's or 100's of thousands of dollars MORE by delaying payment to Uncle Sam, why would you do that? The only reason you wouldn't is if you are in the 10% tax bracket now and have reason to believe that you are going to be in a MUCH higher tax bracket during retirement.<br><br>
Also, you have a limit of only $4,000 for contributions to a Roth ($5,000 starting in 2008). You can contribute up to $15,000 to a 401(k).
 

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<table border="0" cellpadding="6" cellspacing="0" width="99%"><tr><td class="alt2" style="border:1px inset;">If you have a 401(k) that has good, sound investment options it is better to invest in your 401(k) BECAUSE you get taxed later. The advantage of that is that instead of paying the tax money to uncle sam, you get to invest it for yourself and MAKE MONEY off of that tax money. It's simple math... if you can either pay $1000 in taxes now, or pay $2000 in taxes later, but be ahead by $15,000, wouldn't you rather do that?</td>
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Its is true that if you pay tax later with the 401k you will have less money gains then with the money invested in the Roth IRA that is taxed right now and not taxed later. Think of all the compounded interest that is not taxed. In the long run its definitely better with Roth. With the 401k you get slapped with the higher taxes.<br><br>
So I still stand by what I said.... Go with the 401k to get your dollar match and then put the rest in roth IRA!!!
 

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<table border="0" cellpadding="6" cellspacing="0" width="99%"><tr><td class="alt2" style="border:1px inset;">
<div>Originally Posted by <strong>Godaime</strong> <a href="/community/forum/post/6498929"><img alt="View Post" class="inlineimg" src="/community/img/forum/go_quote.gif" style="border:0px solid;"></a></div>
<div style="font-style:italic;">Its is true that if you pay tax later with the 401k you will have less money gains then with the money invested in the Roth IRA that is taxed right now and not taxed later. Think of all the compounded interest that is not taxed. In the long run its definitely better with Roth. With the 401k you get slapped with the higher taxes.<br><br>
So I still stand by what I said.... Go with the 401k to get your dollar match and then put the rest in roth IRA!!!</div>
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In the long run, it is DEFINITELY not better with Roth. For 401(k)s you are taxed at the long-term capital gains tax rate. You're going to pay your marginal income tax rate for pre-tax dollar contributions to a Roth!!! <img alt="" class="inlineimg" src="http://www.mothering.com/discussions/images/smilies/banghead.gif" style="border:0px solid;" title="banghead"><br><br>
That means that if you are in the 25% marginal tax bracket, you will pay a rate of 25% for Roth contributions. For a 401(k), you'll pay only 15% taxes at the time you take withdrawals. And that's only for gains. In fact, you pay higher taxes with a Roth.
 

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<div class="smallfont" style="margin-bottom:2px;">Quote:</div>
<table border="0" cellpadding="6" cellspacing="0" width="99%"><tr><td class="alt2" style="border:1px inset;">
<div>Originally Posted by <strong>Godaime</strong> <a href="/community/forum/post/6498929"><img alt="View Post" class="inlineimg" src="/community/img/forum/go_quote.gif" style="border:0px solid;"></a></div>
<div style="font-style:italic;">Its is true that if you pay tax later with the 401k you will have less money gains then with the money invested in the Roth IRA that is taxed right now and not taxed later. Think of all the compounded interest that is not taxed. In the long run its definitely better with Roth. With the 401k you get slapped with the higher taxes.<br><br>
So I still stand by what I said.... Go with the 401k to get your dollar match and then put the rest in roth IRA!!!</div>
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I just ran the numbers on this again, and your advice would leave me, oh ... nearly <b>1 million dollars poorer</b> come retirement time because of my income, tax bracket and lost contributions each year.<br><br>
One size definitely does not fit all in this case.
 

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V, you actually do have to pay ordinary income taxes on 401K withdrawels. But you're correct that it still doesn't make the Roth the better choice for everyone.
 

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Discussion Starter · #13 ·
Thank you all for responding. It makes a lot more sense that it depends on the individual situation. I thought maybe I was missing something big because everyone seems to say invest in the IRA after employer matching the 401K.<br>
Lisa
 

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Discussion Starter · #14 ·
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<div>Originally Posted by <strong>Herausgeber</strong> <a href="/community/forum/post/6500683"><img alt="View Post" class="inlineimg" src="/community/img/forum/go_quote.gif" style="border:0px solid;"></a></div>
<div style="font-style:italic;">V, you actually do have to pay ordinary income taxes on 401K withdrawels. But you're correct that it still doesn't make the Roth the better choice for everyone.</div>
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And I suppose you have to look at what tax bracket you are in when you would make withdrawals as it could be significantly different than the tax bracket you are in now!<br><br>
Lisa
 

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I think it might help to look at a concrete example.<br><br>
Let's imagine that you're 30 years old, have $1000 to invest in a retirement account, and you currently pay 30% of your income in taxes. If you invest it in a Roth IRA, you'll have invested $700, since you'll need to pay $300 in taxes. If you invest it in your employer's 401(k) plan, you'll have invested $1000, since the contributions are not taxed.<br><br>
Let's assume that your investment earns 10% a year in the 35 years between now and retirement. With the Roth, your investment of $700 will have grown to $19,671 in that time. Whereas with the 401(k), your investment will have grown to $28,102 over the same period. This makes the 401(k) look like the better bet.<br><br>
However, with the Roth, all of the money is yours tax-free, whereas with the 401(k), you have to pay taxes when you withdraw the money. If your tax rate is still 30%, you'll wind up with $19,671 -- just as if you'd originally invested in the Roth IRA. Whereas if your tax rate is now 25%, you'll wind up with $21,076, and if your tax rate is now 35%, you'll have only $18,266.<br><br>
If your tax rate remains the same between now and retirement, there's no difference between the Roth IRA and the 401(k) -- as long as the Roth and the 401(k) earn the same rate of return, the difference in the initial investment will cause the Roth to always be worth 70% as much as the 401(k) (or however much the difference was in the initial contribution).<br><br>
Whether your tax rate will be the same or higher in retirement as it is now is, obviously, unknown. Younger people just starting out in their careers are more likely to have a lower tax rate now than later, which makes the Roth a more attractive option. There's also the question of whether tax rates in general are likely to go up over the course of your lifetime (making the Roth more attractive), and the possibility that you'll move to a state with lower income taxes after you retire (which is a plus for the 401(k)).<br><br>
The Roth IRA is considerably more flexible than the 401(k), which is both a good thing and a bad thing, depending on your interest in investing and your personal financial discipline. With the Roth IRA, you have a much greater range of possible investing options than with your employer's 401(k) plan, so you may well be able to earn a higher rate of return. You can also take your initial investment out at any time without penalty, since you already paid taxes on it, and can take the earnings out for certain reasons at other times before retirement. Whether that last is a good thing depends a great deal on your goals and on your discipline. Oh, and because distributions from a Roth IRA don't count as income in retirement, a Roth IRA may help you stay in a lower tax bracket in retirement.<br><br>
Whew!
 

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<table border="0" cellpadding="6" cellspacing="0" width="99%"><tr><td class="alt2" style="border:1px inset;">
<div>Originally Posted by <strong>Herausgeber</strong> <a href="/community/forum/post/6500683"><img alt="View Post" class="inlineimg" src="/community/img/forum/go_quote.gif" style="border:0px solid;"></a></div>
<div style="font-style:italic;">V, you actually do have to pay ordinary income taxes on 401K withdrawels. But you're correct that it still doesn't make the Roth the better choice for everyone.</div>
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You're right, you're right. Brain fart. <img alt="" class="inlineimg" src="http://www.mothering.com/discussions/images/smilies/duh.gif" style="border:0px solid;" title="duh"> I don't know what I was thinking.
 

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<div class="smallfont" style="margin-bottom:2px;">Quote:</div>
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<div>Originally Posted by <strong>skueppers</strong> <a href="/community/forum/post/6503362"><img alt="View Post" class="inlineimg" src="/community/img/forum/go_quote.gif" style="border:0px solid;"></a></div>
<div style="font-style:italic;">Whether your tax rate will be the same or higher in retirement as it is now is, obviously, unknown.</div>
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Thanks for the example. However, in 99.9% of all cases, your tax rate is LOWER in retirement.<br><br>
I will work up another example with larger numbers if I have the time. It is not a linear accumulation of money. As you invest more, the compounding interest starts accumlating exponentially and the tax question flies out the window. I remember this from a financial seminar I attended not long ago. The difference between a thousand bucks and a million bucks (tax-wise) is significant. And in retirement, let's face it, we're talking millions not thousands.
 
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