The Roth IRA is a great investment account, but is a traditional pre-tax 401k the better choice? I’ll run through the numbers and show which account gives you the most spending power for your retirement. The results may surprise you!
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As financial planning for retirement becomes more essential, many people have to choose between investing in a Roth IRA or a 401k account. Both options can help you save for retirement, but there are significant differences between the two that you need to consider before choosing one. In this article, we’ll discuss what Roth IRA and 401k are, and how you can retire with more using them.
What is a Roth IRA?
A Roth IRA is an individual retirement account that offers tax-free growth and tax-free withdrawals in retirement. It means that you don’t pay taxes on the money you earn in the account, and when you withdraw it, you pay zero tax on the earnings. Roth IRA contributions are made with after-tax dollars. There are income criteria that could limit the contributions to the account.
What is a 401k?
A 401k is an employer-sponsored retirement plan that offers pre-tax contributions. It means that you contribute to the account with money you haven’t paid taxes on so that you can reduce your taxable income each year. However, when you withdraw the money in retirement, you will pay taxes on your earnings. Some employers offer a matching program where they contribute a portion of your contributions to the account.
How to choose between Roth IRA and 401k?
Your decision on whether to choose a Roth IRA or a 401k will depend on your financial situation, including the required contribution, expected retirement age and income, and tax bracket. Here’s some advice on how to decide between the two:
– If you expect to have a higher tax bracket in retirement than you have now, it may be advantageous to contribute to a Roth IRA. By paying taxes now, you avoid paying them in the future when tax rates may be higher.
– On the other hand, if you expect to have a lower tax bracket in retirement or have a higher tax bracket now, it may make sense to contribute to a 401k plan.
– If your employer offers a matching contribution to your 401k, take advantage of it to maximize your savings potential.
– If you’re self-employed, you can open a Solo 401k or a SEP IRA, both of which work similarly to a 401k but offer more flexibility.
How to retire with more using Roth IRA and 401k?
One of the best ways to retire with more is to contribute as much as you can each year to both a Roth IRA and a 401k account. For 2021, you can contribute up to $19,500 to a 401k and up to $6,000 to an IRA account.
Another strategic way to retire with more is to diversify your portfolio by investing in mutual funds, exchange-traded funds (ETFs), and individual stocks. By doing so, you can increase your earning potential and reduce your overall risk.
It’s also vital to rebalance your portfolio regularly to ensure it aligns with your financial goals and adjust as necessary. As you get closer to retirement, it may be beneficial to reduce the risk in your portfolio by shifting to less risky assets such as bonds.
Final thoughts
Deciding between a Roth IRA and a 401k is a personal choice that depends on your financial goals and tax bracket. However, there’s no reason to limit yourself to just one, and contributing to both could help you achieve your retirement dreams faster. Remember, the more you invest, the more you’ll have when you retire, so start as early as possible, stick to your savings plan, and invest wisely.
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The optimal order for ALL of your investing accounts https://youtu.be/R6aCKAlupHM
Very well done.
Great video Jay.
One issue I’ve never seen addressed by any financial YouTuber is this; tax issues wether pretax or post tax are always assumed to be written in stone and they most certainly are not. When I receive a tax break today because I contribute to my 401k I already know I will be taxed at distribution. The problem is, the tax benefits “promised “ in the future are only theoretical. That’s the law on the books today. As we know our national debt problem is only going to get worse and future congresses will be searching for ever more onerous and draconian measures to raise more revenue, who’s to say they wont change tax law and tax Roth IRA and Roth 401k withdrawals ? Double taxation, you say ? Yes , and your point? Better to take the tax benefit today than count on a “promised” tax benefit at some point years into the future IMHO
So I prioritized the pre-tax 401K for the first 25 years and plan switch to ROTH for the next ten years and I did so for 2022 and 2023. In addition I did contribute to my ROTH IRA when I could and will continue to do the backdoor also for the next ten years. My pre-tax bucket is 10x my ROTH and unlikely to catch up due to 55 years being my cut off but I want to increase my amount in there. In addition my husband's income should continue to increase so with the uncertainty around taxes this seems to be the most logical strategy for us.