Roth IRA vs. 401k

No one really knows how taxes will be 40 years from now. So your best bet is to hedge your bets and put some money into 401k and some into Roth IRA. The IRA has a limit on how much you can put into it anyway so you might as well put the rest into 401k, at least up the matching.

 

Depending on the tax you're paying right now, that's most likely your best bet.

Pay the taxes now while your tax rate is lower instead of later when they're higher. Also, by rolling your 401k over, you'll have a lot more investing options. The last few years, my IRA's have done 10%+ whereas my 401k's haven't been anywhere near that. The catch with an IRA is that you have to pay fees. The cheapest, and the company I have my IRA's with, is Vanguard.

Just keep in mind that by rolling your 401k into a Roth, you'll have to pay taxes on all of that. I think you do have the option of splitting the tax into 2 years though.

I would definitely recommend rolling it into a Roth IRA.

 

To expand on what Yonkers was saying...the best way to do it, from what I've read is:

1) Invest enough to get the match in your 401k since that is basically a 100% return.
2) Invest enough to max out your IRA ($5,500) since you tend to get better returns there.
3) Invest enough to max out your 401k ($17,500 minus whatever you contributed in #1 for people under 50).

 

listen to Pugs, he knows what he's talking about.

 

I think there may have been a little confusion between traditional IRA and ROTH IRA.
Traditional IRA is the same as a typical 401K. The money you put in is pre-tax. When you withdraw, the principal & gain will be taxed at the rate at that time.

You put after-tax money into ROTH IRA, the principal and gain is not taxed when you withdraw.

 

You'll have to pay the taxes on the money rolled over out of your pocket. You can't use the money you are withdrawing to pay the tax (well, you could, but you would be subject to an early withdrawal penalty for doing so).

It is actually a very difficult decision, and impossible to advise without knowing your situation. Personally I think Roths are way oversold.

 

I think he's saying what I mentioned earlier. If you roll the money from a 401k into a Roth, you'll have to pay tax on that money. That's the point of a Roth. You pay taxes up front so that you don't have to pay taxes later. All of the money is rolled over, so none actually goes into your pocket, so the taxes due will all come out of your pocket, not out of the money that is rolled over.

Your situation is mostly based on your tax rate right now, and what you think your tax rate will be in the future. In the long run, Roth and Traditional IRA's come out to about the same, assuming there are no big changes in tax rates. This is because the money saved paying tax up front on a Roth IRA could be contributed toward your Traditional IRA, which means there is more money in there to constantly compound. This also means that when you go to pull the money out, you will have to pay more tax because you're pulling out more money. So although your Roth amount will be smaller, in the end, after tax, it will be roughly the same as the Traditional, assuming there isn't a giant gap in the tax difference.

One advantage to a Roth is that you can pull out the money you contributed at any time without penalty, and the interest you've earned after 5 years without penalty. With a Traditional IRA, you can't pull anything out until you're 59.5 without a hefty penalty. So a Roth is a great "savings account" if you want easy access to your money, and a nice place to earn interest.

If you're desperate for money now, a Traditional may be better since it will lower your taxes. You can always contribute to both if you really want to.

 

I have yet to switch jobs so I haven't had this come up yet, but could the OP not just leave the money in the 401k account (the one you used through your previous employer) and let it grow there, while starting a new 401k with the new company and any IRAs that you want on your own?

Obviously you wouldn't contribute to the old one anymore, but are you forced to withdraw or rollover your money from a 401k once you leave a job?

 

Varies by company and plan. Although generally, you are allowed to leave your funds in your old 401K so long as your balance exceeds a certain amount (usually $5,000). That's what I did when I left my old company. I was happy with the investment choices offered and felt no real need to change.

 

If you leave the money, the administrator can distribute it to you early, and hit you with a 20% tax, and if you're under 59.5, you'll have an additional 10% penalty. There's no guarantee an employer will do this, but they do have the capability.

In general, because you have so many more options, you'll make more money contributing to an IRA versus a 401k. So, I don't see why you wouldn't take advantage of this.

 

You are allowed to keep your money in the old one and the old investment firm is happy for you to stay with it. Just be mindful that your old company may have paid some of the fees for you. Now you are on your own.

 

Ah, ok. Definitely see the benefit of rolling it over but if you don't want to/don't have the money to pay the taxes right away, especially if it is a large amount, it may be worth it to leave it there for a while.

 

If you don't have the money to pay the taxes, don't roll it over into a Roth IRA, just roll it into a Traditional IRA, which is basically the same as a 401k. You won't owe any taxes.

 

You don't have to pay the tax right now if you are going to roll the money into another qualified plan.

 

For me 401k early on kind of makes sense because while I am still saving, I don't make as much money so I need more in my pocket, so the tax savings help. But Roth IRA can make sense down the line because there is a good chance you won't be making as much money when you're pulling money out for retirement (because you're no longer working) so your tax rates should be lower. And if you happen to be balling at 70... then who cares how much tax you're paying?

 

If you had a Roth 401(k), you could roll it into a Roth IRA.

 

In general, that makes sense.

Another thing to consider is the difference between income tax rate and capital gain tax rate. If things stay where they are, Traditional IRA is more advantageous.
Ex,
1) You put $100 pre-tax into Trad IRA. In 10 yrs when you withdraw, it doubles to $200. You will pay income tax rate (let's assume 25%) for the 1st $100 and the capital gain rate of 15% for the last $100. Avg rate is 20%. You end up with $160.
You can also move into a different tax bracket because your income when you retire is smaller and you pay a lower rate (compared to now).

2) You pay tax on that $100 now, the same income tax rate of 25%, you are left with $75 to invest in a ROTH IRA. In 10 yrs when you withdraw, it doubles to $150, you don't have to pay any tax.


Then again Congress can change the rate at anytime.

PS.
Is my Math right?