Tuesday, December 13, 2011

Retirement Savings, Without The Strings

For the young and those without emergency funds, the Roth IRA often beats out a 401(k).

It's a perennial question, but one that has taken on new urgency now with the economy so uncertain: Assuming you can't save an unlimited amount, should you fund your 401(k) or a Roth IRA first?

Both a pre-tax 401(k) and Roth IRA let you save for retirement in a tax-advantaged way, but they're basically mirror images of each other. With a pre-tax 401(k), you put salary in before tax and are taxed on all withdrawals. With a Roth IRA, you pay taxes on your wages before you invest, but can withdraw the money in retirement tax-free. In theory, the tax advantages should be equal over time, assuming you put into the Roth IRA the after-tax equivalent of what you're putting into the 401(k) and assuming your tax rate is always the same.

To complicate things, there are also pre-tax IRAs, after-tax traditional (non-Roth) IRAs and new Roth 401(k)s. But since pre-tax 401(k)s and Roth IRAs are of use to the most people, we'll stick to comparing them.

The traditional wisdom has been to put money into a 401(k) first, at least to the extent that your employer matches your contributions. In a typical match, if you put 6% of your salary into the 401 (k), the company will kick in 3%, providing an immediate boost to your savings. That's still good advice for many folks. But for others, particularly younger savers, the Roth now has the edge, for three reasons. Read more....

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