Why a Roth IRA is Better Than a 401k
For many investors, a Roth IRA is a better investment than contributing to your employer’s 401k retirement plan. A Roth IRA is cut from much of the same cloth as a 401k retirement plan, but there are several characteristics that make a Roth IRA a better investment option for many Americans. While this is obviously not true in all circumstances, the tax advantages of a Roth IRA often make it an incredible investment vehicle for to help you accomplish your financial goals for retirement.
A Roth IRA Is More Tax Efficient Than A 401k
The largest benefit of a Roth IRA is its tax-free withdrawals of earnings in retirement. Investors use after-tax dollars from their paycheck that has already been taxed to invest in their Roth IRA accounts. If you withdrawal the account’s earnings after reaching 59 ½ years-old, the earnings are then tax free. This tax-free status is one of the biggest reasons that set a Roth IRA apart from a 401k retirement plan.
Many investors are in a lower tax bracket while they are starting their career, and ultimately they should be in a much higher income tax bracket later in their lives when they are ready to retire. This is a great benefit to Roth IRA investors who pay their taxes early in the investing process. Conversely a 401k retirement plan investor reduces his or her taxable income when he makes an initial investment but pays taxes when funds are withdrawn later in his or her career.
A Roth IRA Is More Flexible Than A 401k
A Roth IRA allows investors more flexibility than a 401k retirement plan. Investors can designate mutual funds as a Roth IRA if they meet the income limits and qualify to invest in a Roth IRA. Investors also have the ability to designate their investment as a self-directed Roth IRA and can decide which investments to exactly include in their Roth IRA.
A 401k retirement plan with your employer often limits an employee’s investment choices to a select few mutual funds and investment options. For example, the federal Thrift Savings Plan which is the government’s equivalent to a 401k retirement plan only offers five different index fund options for investors to choose from. Also while you can take a loan out against most 401k retirement plan, you are severely penalized if you withdrawal your investment from a 401k before you reach 59 ½ years-old. A Roth IRA on the other hand provides you with several opportunities to take an early withdrawal without penalties to pay for qualified exceptions such as a home purchase, educational expenses, if you become severely disabled, or other specific instances.
Additional Investment Characteristics To Consider
Of course there may be times when you need to invest in a 401k retirement plan in conjunction with your Roth IRA. You should consider investing in a 401k plan if your employer offers a matching contribution. Many employers match up to 5% of an employee’s investment contribution which is essentially a 100% rate of return. There is also an income limit that sets a cap to who can invest in a Roth IRA. If you are married filing joint tax returns and earn more than $183,000 per year, you do not qualify to invest in a Roth IRA. In many cases, a Roth IRA is often a superior investment over a 401k retirement plan. A Roth IRA offers investors a flexible investment vehicle to save for retirement while also minimizing the amount of taxes that will ultimately have to be paid. While a Roth IRA is not available to all investors and exceptions can apply, a Roth IRA is often a better investment than a 401k retirement plan.
Photo by Kevin Mulligan
Important Roth Information
Each year, the IRS updates the rules for IRAs. Here are all the details for 2016: