401k vs roth
if a person has a roth ira and 401k or a roth feature on a 401k, what is the optimal way to contribute in order to maximize gains and after tax ditributions?
if a person has a roth ira and 401k or a roth feature on a 401k, what is the optimal way to contribute in order to maximize gains and after tax ditributions?
Permalink Submitted by Clyde Wolf on Fri, 2008-10-31 23:40
Patrick.scholz,
With identical investment choices available most likely the ROTH 401k would be best. This is because the 401k has a higher contribution limit than the ROTH IRA.
Also if your employer offers a matching contribution to the 401k, that would be a tax deferred contributon. Qualified distributions from this matching contribution may be effectively tax free. We all have some amount of standard or itemized deduction and personal exemptions that lower our AGI before tax is computed.
Some folks find it better to take the tax deduction now, and pay tax later.
Everyone’s situation has different requirements. Those requirements may change as we go through life.
Permalink Submitted by Alan Spross on Fri, 2008-10-31 23:43
That depends solely on the individual circumstances of each taxpayer. The prime factor remains the difference in the marginal tax rate in the year of contribution vrs the perceived marginal rate in retirement.
There are several different approaches possible, but all or none of them might apply in the individual circumstances. For example, income might be too high to make Roth IRA contributions and in that case the Roth portion would have to come from the employer plan. For someone that is eligible, I think the Roth IRA is more flexible and the rules more taxpayer friendly than the Roth 401k.
Someone might make pre tax contributions to the 401k to eliminate their top bracket, ie to keep their taxable income out of the 25% bracket. The rest of their deferral limit might be made to the Roth account, more so if they have no prior Roth balance or very little from a percentage standpoint. This is much more art than science.
Most people opt for the up front deduction as evidenced by the 95-5 edge in traditional IRAs vrs Roth IRAs. The more assets you expect to have in retirement, the more valuable the Roth will be. Conversely, if you are more the spender type, want to retire early, do not expect to insure long term care exposure, etc. I would opt for the pre tax or deductible TIRA and pre tax employer plan because your tax rate in retirement will probably not be very high.
Remember, you can make changes from year to year or within a year to your allocation to reflect major changes in financial fortunes.