Roth IRA vs 401k

Roth IRA VS 401K? In this article the difference between these very different kinds of retirement investment plans are laid bare.

The 401(k) has been around a good few years now and many people are quite familiar with it. The basics points to remember are that you can enroll in the plan if your employer offers it as a benefit and that the contributions are paid from gross earnings, with no income tax deduction. Better than this though, some employers are generous enough to match some of your contributions to double your best investment, again with no tax consequences at the time of the initial investment. The level of the match is up to the employer and is something that can be negotiated.

Whilst you would benefit from a beginners guide to investing and using compounding during the duration of your investment in the 401(k) plan, you get the added opportunity to grow the value of monies invested that otherwise would have been paid out in taxes in year one. The deferred taxes, depending on the time invested, can make a huge difference to the final value of your 401(k) plan investment. Upon withdrawal at age 59½ or older, your withdrawals are then liable to taxes.

An alternative to the 401(k) plan participation is the Roth IRA. This can actually be taken up alongside an investment in a 401(k) plan. There are a number of fundamental differences. A Roth IRA is opened with an annual limit to the investment of $5000 if your age is below 50, but $6000 if above this age, with the exception if your income is below the limit then the maximum contributed is your income that tax year.

Contributions to a Roth IRA are made post-tax, but can grow tax-free and are typically not subject to taxation if withdrawals are made when age 59½ or older. Roth IRA withdrawals are subject to taxation if certain restrictions are not met. These include the need to have opened the Roth IRA at least five years prior to the withdrawal, with the exception being a disability that will affect the way withdrawals are calculated for tax reasons. Early withdrawals are still possible before the age 59½, but these are subject to penalties unless for reason of disability. The rules should be carefully reviewed before taking any withdrawal from a Roth IRA to ensure no tax liability for early withdrawal.

There are valid reasons to invest in both a 401(k) plan and a Roth IRA. One is that it splits the tax liability partly to the present and partly deferred until later, which balances both when taxes are paid, and the rates at which tax will be paid now and in the future. Different withdrawal restrictions apply to each investment structure, so having both can also create more options near retirement age too.

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