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Financial Planning / Foolish 401(k)s


Subject:  Re: 401-K vs. Roth IRA Date:  12/31/2001  2:52 PM
Author:  Willmac Number:  14083 of 26142

Your 401k will be taxed as regular income when you take it out. There will be no taxes on a Roth IRA as long as you follow the rules. A rule-of-thumb is that if you expect to be in lower bracket when you retire that you go with the tax deferred rather that the tax-free. Even if you will be in a lower bracket it may be a better to go with a Roth.

You can use a lot of online calculators to predict what your savings and retirement packages (include social security and pensions) will be at your present rate of saving. Generally people stay in about the same bracket.

But think about it. By paying the taxes now you effectively get to put more money in the account. Say you have a regular IRA worth $100,000 when you retire and you have been and will be in the 28% bracket. That money is worth only about $78,000 (or less if it pops you into a higher bracket) when you withdraw it because of taxes (and don't forget about state taxes). A $100,000 Roth is worth $100,000 regardless of how much you take out. So by contributing to a Roth you have effectively increased your contribution by 28% plus and applicable state taxes.

About the 401k having lousy investment choices, my plan does have crappy choices also. However, my plan does have a bond fund and a money market. Instead of keeping my retirement bond and cash investments in my taxable savings I keep them in the 401k. It does get hard when the 401k becomes a large part of your retirement. Furthermore, for stocks that will have long-term capital gains, I try to keep in my taxable accounts because they will be taxed at or less than 20%, which is even better than a tax deferred account.

I would fund the accounts in this order

1. The matching portion of the 401k (usually a 50% return)
2. Then Roths (this could be first depending on the 401k match)
3. Then any other tax free and then deferred plan you can afford.
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