| I need advice!!! 401(k) or Roth IRA?? |
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mopowers
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| I need advice!!! 401(k) or Roth IRA?? |
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I am 25 and have been putting $500 a month into my 401k, which is up to $6000 total. I work for the State of California, so no employer contributions are being made. I also have a pension that I pay into. I will receive 2% at 55 for that which will leave me a %64 of my retiring income when I retire at 55.
My question is, should I continue to put $500 a month into my 401(k), or should I invest that money instead into a Roth IRA through my bank?
Right now, I make about half of what I will in 6 years. It's my understanding that if I can predict I'll be in a higher tax bracket when I retire than I am right now, I should be investing in a Roth IRA. Is this correct?
What do I do??? Thanks a lot!!!
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Thu Apr 03, 2008 7:26 pm |
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coaster
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Who knows what the tax brackets will be. But for starting a new IRA, my opinion is yes, do the Roth. But don't do it through a bank. Do it through an online discount broker or directly with one of the major investment companies such as Vanguard, Fidelity, or T Rowe Price.
~Tim~
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Fri Apr 04, 2008 1:17 am |
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mopowers
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quote:
Originally posted by coaster
Who knows what the tax brackets will be. But for starting a new IRA, my opinion is yes, do the Roth. But don't do it through a bank. Do it through an online discount broker or directly with one of the major investment companies such as Vanguard, Fidelity, or T Rowe Price.
Thanks for the advice! Would you do that instead of the 401k, or split the two of them?
Also, if I do a Roth IRA through one you suggested, can I set up direct withdrawl from my paycheck like I can at my bank (Golden 1)?
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Fri Apr 04, 2008 1:58 am |
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coaster
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Sorry, I don't know anything about public employees' plans, so I can't comment on that. But as far as automatic withdrawal, yes, any investment company can do that. 
oops -- I just noticed you said withdrawal from your paycheck, not your bank account, so I'll have to plead ignorance there, too, but I think it depends on your employer's arrangements for having amounts deducted directly from your paycheck. If you can't have that done, then you can do the periodic automatic bank account withdrawal.
~Tim~
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Fri Apr 04, 2008 4:19 am |
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pf101
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For most people, it's best to invest in the following order:
1 - 401k to company match
2 - Roth IRA
3 - pay off high interest debt
4 - max out 401k
5 - invest in a taxable account
So, if I were you, I'd set up auto deductions to do the Roth and then if you have extra money (which you do), put it in the 401k.
As coaster said, whether or not your company can deposit directly to vanguard/fidelity/whoever is up to them, but all of them will do auto contributions from your checking account on the day of your choice so that's an easy option.
I also agree 1000% with not doing it at your bank. Banks are for banking, not investing.
As far as the pension thing goes, DO NOT rely on this money. First, pensions are going the way of the dodo and, granted, you work for the state so the chance of it going away is slim, but it's still not something you should rely on. Second, the odds of you staying with the state for the next 30-40 years is slim. Plan to save your entire retirement amount on your own. That way, best case, you get the money but don't really need it so you can figure out something else to do or retire a bit early. Worst case, if you don't get the money, you're not screwed.
Your goal should be to invest 10% of your pre-tax income each year.
Congrats on starting early!!
Personal Finance 101
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Fri Apr 04, 2008 6:30 am |
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Avino
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I believe the limit of investing in an IRA is $5000 for this year and will go up by about $500 each year, so even if you have $500 a month, you will be left with $1000 at the end of this year which you would have to invest elsewhere. Look up the maximum IRA contribution, divided by the number of months left in the year, and put that in each month, if you have $500 and started now, you will still be within limits for this year.
~A.
Also blogging @ avinos2cents.blogspot.com
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Fri Apr 04, 2008 6:19 pm |
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mopowers
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quote:
Originally posted by pf101
For most people, it's best to invest in the following order:
1 - 401k to company match
2 - Roth IRA
3 - pay off high interest debt
4 - max out 401k
5 - invest in a taxable account
So, if I were you, I'd set up auto deductions to do the Roth and then if you have extra money (which you do), put it in the 401k.
As coaster said, whether or not your company can deposit directly to vanguard/fidelity/whoever is up to them, but all of them will do auto contributions from your checking account on the day of your choice so that's an easy option.
I also agree 1000% with not doing it at your bank. Banks are for banking, not investing.
As far as the pension thing goes, DO NOT rely on this money. First, pensions are going the way of the dodo and, granted, you work for the state so the chance of it going away is slim, but it's still not something you should rely on. Second, the odds of you staying with the state for the next 30-40 years is slim. Plan to save your entire retirement amount on your own. That way, best case, you get the money but don't really need it so you can figure out something else to do or retire a bit early. Worst case, if you don't get the money, you're not screwed.
Your goal should be to invest 10% of your pre-tax income each year.
Congrats on starting early!!
Thanks for the help guys! I have a couple follow-up questions. I read somewhere that a Roth IRA can't drawn upon without penalty until you reach 59 1/2 years old. Is this true? If so, if I plan on retiring at 55, that sounds like it wouldn't work for me.
Also, it's interesting that you say not to rely on my state retirement plan (CalPERS). I have never heard that. I would think it would be pretty safe seeing how most California public employees pay into it.
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Fri Apr 04, 2008 6:19 pm |
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coaster
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Well, since you don't pay tax on Roth distributions, the 10% you pay on an early distribution is only a trim instead of a shave. I don't think making investment decisions now based on what you speculate tax law might be decades from now is very productive growth-wise. But...... you might look into the exceptions to tax on eary distributions, you might look into what's called "recharacterization," and maybe one of our more-informed members can clear me up on this: can a Roth be annuitized like a traditional? There's a wealth of info on the IRS website --- deciphering it is another story. 
~Tim~
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Fri Apr 04, 2008 8:24 pm |
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efflandt
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Other notes: You can withdraw (already taxed) contributions from a Roth IRA at any time without any additional tax or penalty. Distributions are never required from a Roth (like they are from 401k or IRA at age 70.5). So a Roth IRA may be good as part of an emergency fund, but if you don't need it, it can grow indefinitely tax free. It is just the gains that are taxed if you have had a Roth less than 5 years or are under age 59.5.
Unlike a traditional IRA where a mix of taxable and tax deducted contributions are withdrawn on a pro-rated basis (based on percentage of taxed and untaxed contributions), Roth distributions come from your already taxed contributions first.
So there is no real reason to be afraid of a Roth IRA. Sock away what you can in the Roth while you are young and your tax rate is low, and more later into 401k or IRA when the deduction or staying out of a higher tax bracket is more effective (or no longer eligible for a Roth).
Then hopefully your taxable distributions will be taxed at a lower rate than if everything was tax deferred, and you have retirement flexibility with the Roth for lump sum major purchases without tax consequences.
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Fri Apr 04, 2008 11:10 pm |
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coaster
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Maybe I misunderstood what the IRS website had to say (quite likely) but I thought I read that early distributions from a Roth were subject to a tax rate of 10% (not a penalty, a tax -- though I suppose if you expected to take it out tax-free, the difference between a tax and a penalty is a fine distinction more clearly seen through the eyes of the IRS.)
http://www.irs.gov/taxtopics/tc428.html
~Tim~
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Fri Apr 04, 2008 11:17 pm |
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pf101
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efflandt is correct. You can always withdraw your contributions to a Roth at any time for any reason without any penalties. It is a non-qualified distribution. Qualified distributions may be subject to penalties, depending on the reason for the distribution, your age, and a host of other factors that only the IRS really understands.
OP, as far as the pension goes, as I said, it's likely it will still be there. But, also as I said, it is unlikely that you are going to have the same employer for the next 30+ years. You would be a very very very rare person if you did that.
Basically, what it comes down to is that you should never rely on anyone else to provide for your retirement. Whether that's from an inheritance, social security or a pension, you just never know what will happen so you're better off planning on doing it all on your own. Worst case, you can retire early and live a good lifestyle. However, I know many, many, many people who relied on pensions for their retirement and then had to go back to work in their 70s because their pension was yanked.
Personal Finance 101
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Sat Apr 05, 2008 3:35 am |
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coaster
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OK, but what does this mean in the above IRS Tax Topic on Roth distributions quote:
Part of any distribution that is not a qualified distribution may be taxable as ordinary income and subject to the additional 10% tax on early distributions
??
signed....call me confused 
~Tim~
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Sat Apr 05, 2008 4:33 am |
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pf101
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They key word there is *may*
Here's a copy of a post I made on the subject on another forum. The thread got pretty heated so I won't post it all here. If you want to read the whole debate, PM me and I'll send you the link.
This is covered in IRS pub. 590 (http://www.irs.gov/pub/irs-pdf/p590.pdf) which goes into much more specific detail than the summary you linked. Look particularly at page 65, the first sentence under the heading "Are Distributions Taxable?"
It says "You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s)."
That covers the income tax part and the penalties are covered in the post below. It's more about what they don't say than what they do say. It's all in there, you just have to piece together about 20 different sentences and do some math. The same rules apply to contributions as to conversions but with a conversion you have to wait 5 years before you can access the money without penalty.
Here are some other articles that might help:
https://flagship.vanguard.com/VGApp/hnw/accounttypes/retirement/ATSRothIRADistContent.jsp
http://www.investopedia.com/university/retirementplans/rothira/rothira3.asp
http://www.investopedia.com/ask/answers/07/nonqualified_Roth.asp
http://www.fool.com/money/allaboutiras/allaboutiras07.htm
http://www.quadsweb.com/ira_new/roth.cfm
http://www.nwpluscu.com/ASP/Products/product_4_3.asp
http://www.bankrate.com/cnn/news/dollardiva/20000727c.asp
http://www.wikicpa.com/index.php/Roth_IRA_distributions
http://www.kaspercpa.com/rothirataxation.htm#Nonqualified%20distributions
*start post*
How Are Non-Qualified Distributions Taxed?
The following chart summarizes the tax treatment of Roth IRA distributions.
(match the number under distributed assets to the numbers under the other headings to read the rules - i have bolded the pertinent sections and have only included ones pertinent to this thread)
Distributed Assets
1 - Regular Participant Contributions
2 - Taxable Conversion
Qualified Distributions
1 - Tax free - Penalty free
2 - Tax free - Penalty free
Non-Qualified Distributions
1 - Tax free - Penalty free
2 - Tax free - Penalty may apply
Comments
1 - Income tax and early-distribution penalty are never applied to distributed assets for which no deduction was allowed when the assets were contributed to the IRA.
2 - Already taxed when converted. - Penalty is waived if any one of the exceptions applies and/or it has been at least five years since the conversion occurred.
The earnings on non-qualified distributions are subjected to income tax. In addition, any earnings and taxable conversion amounts that have been converted less than five years before the distribution occurs are subjected to an early-distribution penalty, unless the assets are used for one of the following purposes:
* The distribution occurs on or after the Roth IRA owner reaches age 59.5.
* For un-reimbursed medical expenses - If the distribution is used to pay un-reimbursed medical expenses, the amount that exceeds 7.5% of the individual's adjusted gross income (AGI) for the year of the distribution will not be subjected to the early-distribution penalty. In other words, the amount paid for the un-reimbursed medical expenses minus 7.5% of the individual's adjusted gross income for the year of the distribution can be distributed penalty free.
[/b]
Personal Finance 101
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Sat Apr 05, 2008 7:00 am |
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coaster
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Thanks for the detailed information, Mandy. This is a good example of why the IRS and the current tax code needs to be abolished and replaced with something else. Not ammended, not reformed, replaced. This is just too complicated for average people to understand. Even IRS agents get confused and don't understand. And a good example of why I don't make future plans based on current tax code. 
~Tim~
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Sat Apr 05, 2008 1:57 pm |
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pf101
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Yep, I agree. The ironic thing is that it's getting *more* complicated, not less. The post I copied for you is over 3 years old and when I initially wrote it pub 590 was actually pretty clear in stating that contributions are tax/penalty free. That's not the case now though. It's been re-written so that it's completely unclear unless you know what to look for which is just silly.
Having worked with the govt for 3 years though, I can comfortably say it's not just the IRS. It's all branches. In 3 years I lost complete faith in and respect for our government because I just saw over and over that they were more concerned about what was best for the members of Congress and the in-fighting that goes on between the two houses than they were about what was best for the people that elected them. It was sad.
Anyway, glad the info helped. I know it was a lot but I figured better too much than not enough.  The fact that I've had this debate a few dozen times since I started doing this (including with members of my family - who still don't believe me  ) made it easy to pull together.
Personal Finance 101
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Sat Apr 05, 2008 2:10 pm |
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