kpow08
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| 401k vs roth |
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I am currently putting 15% into our companys 401k plan. Salary is around 75k per year. Company matches 50% up to 8%. 401k plan has netted an average of 8% return over last 4 years. I was wondering if it would be a better idea to take that 7 percent the company is not matching and start investing it in a roth. What are some thoughts out there about this idea?
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Fri Jan 20, 2006 3:41 am |
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Martin
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Obviously you want to make sure you get all the company match you can. After that the choice between different retirement plans is mostly a choice when you want to pay your taxes. Consider this example:
You have $4000 of pretax funds available to invest for retirement, your effective tax rate is 20%, you invest for 20 year at 8%.
Roth: You pay your taxes now, so you have $3200 to invest. After 20 years it turns into $16,000, which you can take out tax free.
Reg. IRA: You invest $4000 for 20 year. It turns into $20,000. If your tax rate in retirement is also 20% you can withdraw $16K after paying your taxes.
Of course this is a very simplified example, but hopefully it shows that the choice between IRAs depends in part on your current tax rate and your expected tax rate when you want to take the money out. Having said that, Roth IRAs provide added flexibility such as no RMDs, which can be very attractive depending on your siguation in retirement.
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Fri Jan 20, 2006 4:12 pm |
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MattL
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I would put 8% in the 401k, then max out the ROTH, then go back to the 401k with any additional money you want to contribute.
Debt Elimination
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Fri Jan 20, 2006 4:49 pm |
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Martin
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I apologize for creating confusion with my post. Maybe this will at least explain what I was trying to say before.
quote:
Originally posted by coaster
Sorry, but the example is a little misleading. You still have $4000 to invest, you just pay the taxes out of the balance of your income. For example if your AGI is $50,000 with 401(k) contributions as is, if you divert $4000 to a Roth IRA, your AGI will be $54,000 and taxed accordingly.
I was trying to put the two IRA types on the same footing by starting from the same pre-tax earnings for simplicity.
I agree with you that since the contribution limits for Roth IRAs are the same as for regular IRAs, it is better to put away post tax dollars than pre tax dollars.
However, the total after-tax return on pretax dollars is the same for both retirement types unless I am missing something. We would start with $5000 pre-tax, put $4000 into a Roth after paying taxes and have that grow to $19,812 over 20 years. Our return on pretax dollars would be $19,812/$5000 - 1 = 296%. For the reg. IRA we get $15,850/$4000 -1 = 296%.
The difference is that we can effectively put $5000 of pretax dollars to work in a Roth compared to $4000 for a reg. IRA, as you pointed out.
quote:
Originally posted by coaster
Also, after 20 years, even assuming the measly 8% return, investing $4000 every year turns into $197,672. 
I am assuming that we make a single investment of $4000 rather than contributing $4000 annually  . I wish I could figure out a way to make $4k grow to $200K in 20 years!
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Fri Jan 20, 2006 6:50 pm |
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Rolo
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| Re: 401k vs roth |
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quote:
Originally posted by kpow08
401k plan has netted an average of 8% return over last 4 years.
This is why I am a stickler for precise vernacular.
Your 401(k) plan did NOT earn 8%...THE INVESTMENT WITHIN your 401(k) earned 8%... To answer your question, I would have to see what investments you had available to you in your 401(k)...it just might need tweaking.
quote:
Originally posted by kpow08
I was wondering if it would be a better idea to take that 7 percent the company is not matching and start investing it in a roth.
Same issue...you do NOT invest in a Roth. A Roth IRA is a set of tax laws, not an investment.
If you do not know the particulars of your 401(k), then you do not know the particulars of a Roth; one can only expect that you will average the same kind of return only lose the immediate tax break.
Examine your investment options and make your 401(k) holdings perform the best that they can. If you can beat that performance + tax break with outside investments, then the answer to your question is 'yes'.
"Expect me when you see me."
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Sat Jan 21, 2006 2:52 pm |
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kpow08
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| Thanks |
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Thanks for all the feedback.
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Thu Jan 26, 2006 3:57 am |
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Jaszbo
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I agree with MattL, which is what Dave Ramsey, Clark howard and Suze Orman all say. Do your 401k plan matching and then go to your Roth IRA and max it out and then come back to your 401k plan and increase that if you can.
If you gave me a choice between only a Roth IRA and a 401k plan and there's no matching I would pick a Roth IRA for all the advantages it has. Does your 401k plan allow you to invest in REIT index fund? Almost every 401k plan I've seen doesn't allow you to invest in that fund or how about emerging maket? It's not that I'm recommending these funds, but you can pick your firm and you will have more choices and also you'll have more control over your money as to what you can pull out and things of this nature.
If you are in the 25% tax bracket now, what will you be when you are closer to retirement? It's a guess and nobody knows. Taxes could be 15%, or it could be 35%, more people assume taxes are going to go up, but nobody knows for sure if you are young. I would without a question do both, you want pre and post taxes invested.
If you are really young and your tax bracket doesn't change in reality the Roth IRA if invested in the exact same fund outperforms the pretaxed 401k plan, but I believe it takes close to 20 years. But it really doesn't matter that much, it's not the reason that I would recommend a Roth IRA.
The only people I know who do not recommend a Roth IRA are those that speculate that the Roth IRA is too good to be true. I've met many respected investors who believe eventually the Roth IRA will be taxed. I personally don't believe this and as a mater of fact the IRS wants you to invest as much as possible in all tax sheltered retirement acounts, they want to be less resonsible and take the burden off of social security. Also now there's the Roth 401k, so does anything indicate that it will be taxed? I personally think every person should have a Roth IRA unless you are closer to retirement.
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Thu Jan 26, 2006 3:12 pm |
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JCook
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You have been given some very good advice here but just make sure that if you go with the Roth along with your 401K that you do not let yourself get lazy and not make the investments in the Roth.
One advantage with the 401K is that it is taken directly from your pay. If you go with the Roth you may want to make it an automatic withdrawal so you will not forget to do it or find something else for this money.
Your Roth will not outperform your 401K if you neglect to fund it.
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Sun Jan 29, 2006 3:51 am |
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Jaszbo
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I agree with you Jcook. Actually I would recommend automatic withdraws from your checking biweekly or monthly, "Pay yourself first", so the money is already allocated monthly for your Roth IRA. I also think it's easier to increase your Roth IRA contributions. You can start out doing say 50 dollars biweekly and then slowly increase each year by 25 bucks or so and when it gets to around 150 biweekly you are close to maxing out the Roth IRA 3900 out of the 4000.
The problem with starting out the Roth IRA compared to a 401k plan also is your investment options. The place I have my Roth IRA most of their funds costs 3k to get started and yet you can only put 4k max into each fund. Therefore your first year you can only get into one single fund, so I would go with a life cycle fund, which is a managed fund of funds with the allocation based on your age.
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Sun Jan 29, 2006 4:21 pm |
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