What is the right place to set aside and invest your money for retirement? Both the 401(k) and Roth IRA are useful, popular retirement vehicles. Each has its advantages and disadvantages.
A 401(k) is an employer-sponsored plan that allows savers to defer taxes to a later date. If your employer offers one, it works like this:
You sign up for it and choose your investments from the options available. Then, your employer redirects money from your paycheck to your 401(k) before paying federal income tax on the money. The money is tax-deferred, meaning it does not count as your taxable income for the year. For 2015, you can put up to $18,000 of pre-tax money into your 401(k).
Also, employers often match your contribution up to a certain percentage of your total salary. This percentage usually ranges from 3% to 6%, and the full match can vary. This is like getting free money from your employer. Contribute at least enough to secure that match.
Because you didn't pay income tax when you contributed, you pay when you withdraw. If you take out the money permanently before you turn 59½, you pay a 10% penalty in addition to the income tax on the withdrawals.
A Roth IRA lets you withdraw funds at retirement age without any additional taxes, because unlike with the 401(k), you pay them upfront. Here's how it works:
You set up a Roth IRA with an investment manager of your choice. You take your after-tax money from your bank account and deposit it in the plan on your own. Your employer has no connection with your IRA.
In 2015, you can contribute $5,500 to your Roth IRA. However, there are income limits. If you make more than $116,000 as an individual or $183,000 as a married couple, you can't contribute as much – or at all.
Because you paid taxes on the contributions already, you can withdraw them without taxes or penalties at any time. This gives you flexibility if you're in a cash crunch. When you reach 59½ (and you have the account for five years), you can withdraw all the money, including years of gains, tax-free.
A 401(k) is great if:
• Your employer matches your savings.
• You want to lower your taxable income now.
• You make too much money to contribute to a Roth IRA.
• You struggle to save without automatic payroll deductions.
• Your retirement income will be less than your current income. If you think this is case, you pay less in taxes by deferring them until retirement.
A Roth IRA is for you if:
• Your employer doesn't offer a 401(k).
• You want more investment options than your 401(k) provides.
• You want your savings to grow tax-free.
• You want more flexibility in accessing your own contributions.
• Your retirement income will be more than your current income. If you believe that will happen, you pay less in taxes by paying them now rather than in retirement.
Both plans, which typically invest in mutual funds offering stocks or bonds, offer great tax advantages for saving for retirement.
Additionally, Roth 401(k)s and Traditional IRAs exist as potential options. We will help you determine which plan is best for you based on your particular financial situation, goals and objectives.
Contact us today and let us help evaluate your personal situation to determine which is the best for you!