Is A Roth IRA Better Than A 401K?

Understanding the differences between a Roth IRA and a 401(k) plan is crucial as you plan for your retirement. Both can help you get the most out of your savings while you are still working. It might not sound like the most exciting task, but planning for your financial future should take priority so that when it’s time to retire, you have a solid financial plan in place.

401(k) Plans At a Glance

A 401(k) is offered by an employer and is used as a form of saving money for retirement. In some cases, you might be automatically enrolled into a plan or you may have to opt in, depending on your employer.

You get to decide how much of your pay you invest and your employer transfers the funds. Money transferred is before taxes and is invested in bonds and stocks. Plus, contributions to your plan during the year could lessen your taxable income and some employers match what you contribute.

If you make any early withdrawals from your 401(k) plan, you’ll be responsible for paying taxes and a potential 10% penalty. After age 59 ½, your withdrawals will be taxed like regular income.

Changes To The 401(K)

Congress has broadly been in favor of requiring the automatic set up of 401(k) plans by employers for eligible employees, with a 3% savings rate. With this, an individual’s savings rate could go up 1% every year until it reaches 10%.

In March of 2022, the House passed this legislation practically unanimously. It’s called the SECURE Act 2.0, or Setting Every Community Up for Retirement Enhancement Act.

If President Joe Biden and the senate agree to this proposal, the SECURE Act would also:

• Raise the age from 72 to 75 to take the required minimum distributions.
• Give part-time workers the opportunity to contribute to 401(k)s.
• Give employers the option to match your student loan repayments with a 401(k) contribution.
• For workers ages, 62 to 64, raise the after-tax catch-up contribution cap to $10,000.

Roth IRAs

A Roth IRA (individual retirement account) is almost the same as a 401(k) but with different tax rules.

Instead, you contribute money after taxes and don’t pay any tax when you make withdrawals. The investments in your account could be made up of stocks, bonds, mutual funds, and more. And you can set up automatic deposits from your paycheck, just like a 401(k).

And just like a 401(k), you could get a 10% penalty if you withdraw funds early from the earnings of the account, but not from your contributions. Best to wait until after age 59 ½ to avoid penalties.

Possible Roth IRA Changes On The Horizon

Individuals with incomes of over $144,000, and joint filers making over $214,000, aren’t eligible to make direct contributions to their Roth IRA accounts starting in 2022.

The backdoor Roth IRA is a loophole that’s been used by the wealthy for a long time. This loophole entails unlimited after-tax contributions into traditional IRAs or 401(k)s, and switching them to a Roth IRA so they can withdraw tax-free funds in retirement.

This loophole could have been eliminated by Congress in 2021 through Biden’s Build Back Better plan. Though the spending plan passed, it went through some alterations before approval. So best to keep an eye on this possible change.

401(K) and Roth IRA: Which To Choose?

It’s important to consider many factors when choosing a retirement plan, like your income, your projected income tax bracket at retirement, and your 401(k) investment options.

Invest in a 401(k) if your income is over the Roth IRA contribution limits. Reviewing the 401(k) investment choices offered by your employer might be a good place to start if your income sits within the limit allowed for Roth IRA investments.

Keep in mind the different tax rules of both plans. One is taxed before contributions, and the other is taxed once you retire. If you suspect your tax bracket may be low at retirement, a 401(k) might be best. If you suspect the opposite, a Roth IRA could be the way to go.

The Takeaway

Planning ahead for retirement is crucial. Choosing the right plan is just as important. Do your research and think ahead to what your earnings could be closer to retirement so you can make the best choice. Better to have a bit of gold to spend during the golden years when it might count the most.