Which Tax Move is Right For You: 401(K) or ROTH IRA?
Contributing to at least one type of retirement account faithfully is crucial if you ever hope to retire. In most cases, Social Security funds will not be enough to sustain you, and your cash savings probably won’t have the opportunity to grow the way they would if you had invested that money all along.
When it comes to choosing between a 401(k) and a Roth IRA, there really is no perfect answer. Your individual situation will impact which plan works best for you, and even then, there are several different ways to look at it.
It’s also important to note that you don’t have to pick one type of account over the other.
A 401(k) is an employer-sponsored deferred contribution retirement plan. You sign up for a 401(k) plan in your workplace and choose investment options within the plan. Your workplace takes money out of your paycheck before income taxes are taken out and deposits this in your plan. In some workplaces, your contributions are matched by the employer.
Then, when you reach retirement age, you can take money out of the 401(k), but those withdrawals are subject to income tax – since you didn’t pay it earlier, you have to pay it later on. (The benefit of the deferred tax structure is based on the assumption that you’ll be in a lower tax bracket in retirement compared to your prime earning years.)
With a Roth IRA, you can set up an account, choose investment options, and then directly deposit after-tax money into the Roth IRA. Then, when you meet a few basic requirements (once you’re 59 1/2 years old or older, and have had the plan for five years or more), you can withdraw both your deposits and investment gains completely tax free. You can also withdraw funds penalty-free to pay for a child’s education or a down payment on your first house.