Do you have extra cash flow every month, no high-interest debt, and a strong emergency cash cushion? Then you’re probably ready to start building your wealth more actively! But where should you start? 401(K) or Roth IRA?
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Which Takes Priority: 401(k) or Roth IRA?
When it comes to saving for retirement, many individuals find themselves torn between contributing to a traditional 401(k) or a Roth Individual retirement account (IRA). Both options offer unique advantages, making the decision even more challenging. However, understanding the differences and potential benefits of each can help you make an informed choice that aligns with your financial goals.
First, let’s delve into the basics of these retirement savings plans. A 401(k) is an employer-sponsored retirement account, while a Roth IRA is an individual account that you can contribute to on your own. Both plans offer tax advantages, but they differ in terms of when the taxes are paid.
A 401(k) is funded with pre-tax contributions. This means that the money you contribute to your 401(k) is deducted from your taxable income in the year it was earned, resulting in immediate tax benefits. However, when you withdraw the funds in retirement, you will pay taxes on the accumulated amount, including any earnings.
On the other hand, a Roth IRA is funded with after-tax dollars. This means that the contributions you make to a Roth IRA are already taxed in the year you earn the money. However, when you withdraw the funds in retirement, both your original contributions and any earnings are tax-free, as long as you meet certain criteria.
So, which plan should you prioritize? The answer depends on several factors, including your income, tax bracket, and future financial goals. Here are some key considerations:
1. Employer Matching: If your employer offers a matching contribution to your 401(k), it’s usually wise to prioritize this option. Employer matches are essentially free money, providing an instant return on your investment.
2. Tax Bracket: Consider your current and expected tax bracket in retirement. If you are in a higher tax bracket now and expect to be in a lower one during retirement, a traditional 401(k) may be more advantageous. Conversely, if you are in a lower tax bracket now and anticipate being in a higher one in the future, a Roth IRA could be more beneficial.
3. Investment Options: Evaluate the investment options and fees associated with your employer’s 401(k) plan. Some plans have limited investment choices and higher fees, which may make a Roth IRA a more attractive alternative.
4. Future Tax Rates: Consider the possibility of future tax rate changes. While no one can accurately predict tax rate fluctuations, it is worth considering diversifying your income sources to mitigate potential tax liability. By having both a 401(k) and a Roth IRA, you can potentially tap into the advantages of both plans in retirement.
5. Contribution Limits: Be aware of contribution limits imposed on both plans. As of 2021, the maximum annual contribution for a 401(k) is $19,500, while a Roth IRA has a maximum annual contribution of $6,000 ($7,000 if you are aged 50 or older). If you have the means, you may consider maxing out both plans if allowed.
It is important to note that there are income limitations for Roth IRA contributions. If your income exceeds a certain threshold, you may not be eligible to contribute directly to a Roth IRA. However, there are ways to work around this, such as utilizing a backdoor Roth IRA conversion.
In conclusion, choosing between a 401(k) and a Roth IRA requires careful consideration of your specific circumstances. While employer matches and tax brackets may lean in favor of a certain plan, diversification and long-term tax planning should also factor into your decision. Ultimately, consulting with a financial advisor can help you navigate the complexities and determine the best path forward to secure a comfortable retirement.
Good video but what about increased tax brackets in the future (jobs act expires soon) and the widow tax torpedo in later retirement/ medicare costs etc. tax free roth 401k/ira keeps you clear of these higher tax/income issues.
Been researching on this topic on YouTube for a day. You did a better job than all other YouTubers i watched
Truly no doubt, A good way of growing and saving your money is through investing. You don't need to have much before you can invest. "That little money you have now can make you millions if you invest it wisely".
I wasn't financially free until my 40's and I'm still in my 40's, bought my second house already, earn on a monthly through passive income and got 4 out of 5 goals, just hope it encourages someone that it doesn't matter if you don't have any of them right now, you can start TODAY regardless of your age INVEST and change your future! Investing is a grand choice I made.
Roth IRA or Roth 401(k) 's can help you save on taxes in retirement. Not only are withdrawals tax-free at 59 1/2 , it won't impact the taxation of your Social Security benefit and Medicare premiums.This is an important aspect of a Roth accounts that most people are not aware of.
What if the company doesn’t do company match? Would it be ideal to invest in a 401(k) or 403B first in that situation or invest in Roth IRA first?
Imagine thinking the gov won’t increase taxes in the future lol. Roth all the way
I make $91,000 in California and my marginal is 22% and I’m 24 yrs old. Doesn’t it make sense for me to contribute to Roth if I intend to spend significantly more at age 65 than what I’m making now at age 24? Spending and earning a lot now doesn’t necessarily mean you won’t spend more on the future, right?
I appreciate that you give sophisticated information, and put it simply for viewers while also treating us with respect intellectually
I have heard, contribute to 401k enough to get the full match. Then work on maxing out ROTH. Then with leftovers contribute to 401k or traditional ROTH.
Would 401(K) rules apply to SIMPLE IRA's ass well? I work for a smaller company and are offered SIMPLE IRA's with a 3% match, $15,500 deferral limit in 2023.