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Which Retirement Account Is Right For Me?

Unless you’re new to the personal finance scene, you probably already know that you should be socking away a good deal of money into one of those handy-dandy retirement accounts to prepare for your future. This is especially true for the twenty-somethings out there who have years upon years for our money to ride out the recession and start riding the stock market wave into recovery.

We all thought we knew everything there is to know about 401(k)s and Roth IRAs until the new retirement tool waltzed in like he owned the investment-world. Well, hello there, Mr. Roth 401(k). You’re looking mighty attractive, aren’t you?

Here’s the deal. Roth investments are amazing for one simple reason:

The earnings you make from any Roth investment are 100% tax-free when distributed to you in retirement.

So, even though the money you contribute to your Roth IRA or Roth 401(k) has already been taxed, any—and I mean ANY—earnings you make from your Roth are not taxed. At all. This is why Roth IRAs are such an amazing retirement tool, but also why they come with some limitations, including contribution limits, that weed out the uber-rich.

If you’re new to retirement accounts, I put together a very minimal table showing the basic key points about these three types of retirement tools, the 401(k), Roth 401(k), and the Roth IRA:

Compare the differences between a Roth and Traditional IRA and 401(k)  plan.

*These are just the bare basic stats on these retirement tools.
**$16,500 is the max total you can contribute to both a 401(k) AND/OR a Roth 401(k).

As you can see, there are pros and cons and several differences among each account. Here are more fun facts about these retirement investments:

Roth 401(k)

  • This type of investment is relatively new, so they are pretty rare. They haven’t become really popular just yet mainly because companies aren’t willing to hire more personnel to help manage the Roth 401(k). If your employer offers this type of retirement, I would definitely ask your HR office for the details!
  • As I mentioned in the bullet above, the max is $16,500 – but only to the extent that you don’t contribute to a traditional 401(k). So you can only contribute a max total of $16,500 to either account (for example, you could contribute $8,250 to each account).
  • Roth 401(k)s are not subject to the income limitations that Roth IRAs are! No matter what you make, you should be able to contribute.
  • Employers are allowed to match contributions, but you’ll have to ask your HR department more about that for your particular company.
  • Since we can’t predict the future (try as we might), we have no idea how much higher or lower our taxes will be in 30 years; the Roth 401(k) dodges the risk of high future taxes by having 100% tax-free distributions when you retire.

Roth IRA

  • To be eligible to contribute to a Roth IRA, you must have had earned income in that year. This means that you can’t use gift or scholarship money.
  • You cannot contribute more than you make (see the first rule).
  • You can invest in many different things: stocks, bonds, mutual funds, etc.
  • Did I mention that all the earnings from a Roth IRA are tax-free?

401(k)

  • The biggest benefit to this retirement tool is the employer matching. Most companies offer some sort of matching deal up to certain amounts that you contribute. For example, your company may match up to 5% – but you’ll have to contribute at least 5% to get the full matching. It’s generally understood that you should contribute at least up to the amount that is matched; otherwise you’re passing up free money.
  • You’re employer maintains this plan (similar to a Roth 401(k)), so it doesn’t require much effort from you, the employee. It’s simple to set up automatic withdrawals that will be deposited right into your 401(k) account.
  • In this day and age, there are many options available to us to help plan for a prosperous retirement. If your company offers more than one retirement option, it’s a great idea to do a bit of investigative work so you can tailor and tweak your retirement plan to suit your future needs.

So, keep on putting that money away every payday and you can rest easy knowing that your beach house and country club memberships will be fully funded whenever you’re ready to retire!

Read more about how to start saving for retirement, or read a comparison of online brokers where you can open an IRA online.

About Amber Gilstrap

Amber is a twenty-something CPA from Kansas City, Missouri who loves writing, working out, and---of course---finding fresh ideas for saving money. Follow her on twitter @ambergilstrap.

Comments

  1. The government will undoubtedly declare a fiscal emergency and renege on their promise to not tax gains on Roth 401ks. Anyone foolish enough to trust the government and choose a Roth 401ks deserve to be screwed by them.

  2. I’d actually agree with Mike on this one. I don’t think its that out of the question for the Federal Government to consider taxing roth distrubtions, at let’s say 15%, sometime down the road. Don’t think it could happen? There was a time not too long ago when social security was a sacred income stream that no one could ever imagine being taxed. Today, the feds terst SS benefits vs. income and tax those benefits at certain levels.

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