How to Decide Between 401(k) & Roth IRA

by Cindy Quarters

A 401k and a Roth IRA are two different types of retirement savings accounts, and as such the investments in these accounts are long term. There are substantial financial penalties for withdrawing any of your money before you reach age 59 1/2, except under certain limited circumstances. Choosing between the two types of accounts will depend on what your goals are, how much money you plan to invest, and which plans are available to you.

Check to see if you have a 401k retirement plan available to you through your employer. If so, this could be your best choice, as employers often contribute to your 401k by matching a certain portion of the money you put into the account. This is essentially free money, and it is not a feature of the Roth IRA. However, when a company is struggling and needs to cut costs, it often does so by eliminating the matching on 401ks.

Determine your exact annual salary. If you make over $107,000 in 2011, or if you and your spouse combined make over $169,000, you can not open a Roth IRA. The 401k is your best option in this case.

Evaluate your current income situation. If you are in a relatively low tax bracket, a Roth IRA might be your best choice. Contributions to a Roth IRA are made with post-tax money, which means you have already paid the taxes on it. As a result, no taxes are due once you begin making withdrawals from your IRA account at age 59 1/2.

Decide how much you can afford to have your current take-home pay decrease. When you contribute to a Roth IRA, the money is taken directly out of your pay check. You are still responsible for the same amount of taxes. If you choose to contribute to a 401k, the money is taken from your pay prior to taxes being figured. This decreases your tax debt at the time, but you must pay taxes on the money once you begin to withdraw it during retirement.

Consider how much money you want to be able to save for retirement. For 2011, the Roth IRA limits you to an annual contribution of $5,000, or $6,000 if you are age 50 or over. If you want to contribute more than that, a 401k may be the better choice.

Tip

  • You can choose to have both a Roth IRA and a 401k in many situations. Check with a tax professional to see if this is the best choice for you.

Warning

  • Once you put money in your retirement account, it is best if you can leave it there until you retire to avoid any penalties. In some cases you can remove money without penalties to purchase your first home, to pay medical bills or for certain other situations. Check carefully before making an early withdrawal so you don't end up paying a lot in penalties.

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