Forgive me, I know a hundred people have probably asked this question!

My partner just starting working at a new company. They have a 401k plan but don't match in the first year of employment. Should she still start putting money in now or max out her Roth IRA this year instead?

She's 23 and making about $30,000

Thank you!

Should she still start putting money in now or max out her Roth IRA this year instead?

Max out the Roth before a non-matching 401K.

rad

If she is not concerned about tax consequences, go for the Roth. But if she needs to scrape as much money as possible, getting the tax deductino from the 401k contributions may still be of value. Remember, 10% of her pretax salary ($3k) is the roughly the same as 12.5% after tax (assuming a 25% tax rate), or $3750. This means that it costs $750 more to put $3k into a Roth than it does to put it into a 401k. If the fund selection in the 401k is OK, then don't just dismiss it.

Assuming my math is all correct...

>Remember, 10% of her pretax salary ($3k) is the roughly the same as 12.5% after tax (assuming a 25% tax rate), or $3750. This means that it costs $750 more to put $3k into a Roth than it does to put it into a 401k. If the fund selection in the 401k is OK, then don't just dismiss it.
>
Ah,but aren't you looking at the wrong end? She's only 23. At age 65 what does the taxed vs untaxed retirement savings net if later on, at a higher salary, her company begins to match in the 401K? I tried playing around with the fool calulators but I wasn't sure I was doing it correctly because the Roth vs. 401K assumes all or nothing.

My gut suggests she's better with a Roth that she could continue for 30 years to net $400K tax free at that point. Now if she had that in a 401K that increased well above the $3K a year and had matching later in her career, she'd probabaly have a million in her 401K which would kick her into a high tax bracket while she'd still have $400K of her Roth tax free. Not sure my assumptions are correct, am willing to hear discussion.

My gut suggests she's better with a Roth that she could continue for 30 years to net $400K tax free at that point.

I hope she can't continue the Roth for 30 years because she ends up above the maximum income to contribute which is why it's even better for her to do it now. If she's qualified to do it for 2003 and will have no matching and can manage the maximum, she should go for it. Then max it for 2004 and then start the 401K when matching will kick in(Sept '04 ?).

rad

Ah,but aren't you looking at the wrong end? She's only 23. At age 65 what does the taxed vs untaxed retirement savings net if later on, at a higher salary, her company begins to match in the 401K? I tried playing around with the fool calulators but I wasn't sure I was doing it correctly because the Roth vs. 401K assumes all or nothing.

I am thinking that at that age I need all the disposable income I can get, and don't want to waste $750...

I prefer the Roth IRA because it is less risky. This is because I know what the tax consequences will be. With a 401(k), you have to worry about what Congress will do to tax rates well into the future, as well as guesstimate how much you will be making.

Should she still start putting money in [the 401(k)] now or max out her Roth IRA this year instead?

She's 23 and making about $30,000

First, does she have a well-funded emergency fund? This would typically be 3 to 6 months of living expenses in something reasonably liquid and reasonably safe, such as a money market account, a money market fund, or a well-paying savings account.

Since she probably has 35 to 40 years more of work and she is already interested in investing, my guess would be that she will be in a higher tax bracket in retirement than she is now. (Of course we really don't know that.) That would tend to make a Roth IRA more favorable than an unmatched 401(k).

Another advantage of a Roth IRA is that your partner has just about the entire investment universe open to her, so she could go with the investments that make the most sense to her with the most appropriate custodian (e.g., if she invests in individual stocks, having a discount stock broker for the Roth IRA custodian makes sense, or if she prefers to put everything in the Vanguard Total Stock Index Fund, it may make more sense to have the Roth IRA custodian be Vanguard). Contrast that with a typical 401(k), which is usually limited to just the investments offered by the particular 401(k) plan and often have higher fees than one can find with a well-chosen investment with a well-chosen Roth IRA custodian.

Another consideration is that one doesn't really know what will really be the most favorable tax treatment for retirement. Some diversification of tax treatments may be reasonable. Since your partner will probably be contributing to a 401(k) next year when she is eligible for an employer match, getting some money in a Roth IRA now could be the start of the diversification of tax treatments.

There could be other considerations. For example, how disciplined is your partner on saving/investing? Payroll deduction is a very effective way to save without a chance of spending that money (unless one uses credit to spend more than one takes home). Then again, many Roth IRA custodians also have a way to automating the removal of money from one's bank account ("Asset Builder", "Automatic Investment Plan" or some other name that basically says they direct debit the checking account on a regular basis).

If the 401(k) has reasonable investment options and reasonable fees, if your partner has more to invest than she can shelter in her Roth IRA, she may want to consider putting the difference in the 401(k).

Hopefully she won't make the same mistake that I made when I started contributing to my 403(b): I didn't seriously consider expenses or the effects of returns, so I was in an under-performing investment for a few years before I switched to a low-cost 403(b) provider.

I prefer the Roth IRA because it is less risky. This is because I know what the tax consequences will be.

This is really a funny statement. Let me know what your crystal ball says about mean-tested social security.

rad

I prefer the Roth IRA because it is less risky. This is because I know what the tax consequences will be.

This is really a funny statement. Let me know what your crystal ball says about mean-tested social security.

rad

It is a very serious statement. The likelihood that withdrawals from a Roth IRA will someday be taxed is infinitesimal. Politicians won't be able to do it.

Social security is a joke. I wish they would just scrap the whole idea, but I know it will never happen.

The likelihood that withdrawals from a Roth IRA will someday be taxed is infinitesimal. Politicians won't be able to do it...

Oh, I'm not so sure about that. We have many intelligent politicians, note I did not say "statesmen", that are losing sleep on how to take our earned wealth, Roth IRA included.

TB

The likelihood that withdrawals from a Roth IRA will someday be taxed is infinitesimal. Politicians won't be able to do it...

Oh, I'm not so sure about that. We have many intelligent politicians, note I did not say "statesmen", that are losing sleep on how to take our earned wealth, Roth IRA included.

TB

They wouldn't get away with taxing a Roth IRA. It would be a political death sentence.

If you disagree, that's fine. I'm not going to argue about it.

They wouldn't get away with taxing a Roth IRA. It would be a political death sentence.

Back in the olden days when I started my TSA at Penn State, you could take out money and just pay the taxes on it. Two years later, there was a 10% penalty added to the price of withdrawal and I believe this was a Federal tax change. Remember that high income folks don't have Roths for the most part because they couldn't contribute or convert and they all vote.

rad

They wouldn't get away with taxing a Roth IRA. It would be a political death sentence.

Back in the olden days when I started my TSA at Penn State, you could take out money and just pay the taxes on it. Two years later, there was a 10% penalty added to the price of withdrawal and I believe this was a Federal tax change. Remember that high income folks don't have Roths for the most part because they couldn't contribute or convert and they all vote.

The wealthy only make up a very small proportion of the votes in America. Roth IRA contributions begin phasing out at $95,000 for single filers and $160,000 for married couples. There aren't a heck of a lot of voters in these categories.

MadCapitalist: "I prefer the Roth IRA because it is less risky. This is because I know what the tax consequences will be."

Until Congress changes the law. I fully expect that one day Roth IRAs will be taxed just like non-deductible IRAs. There will be much hand wringing and cries of crisis, etc., but the only question for me is when, not if.

"With a 401(k), you have to worry about what Congress will do to tax rates well into the future, as well as guesstimate how much you will be making."

I fail to see why this guesstimating is any different.

Regards, JAFO

MadCapitalist:

<<<<They wouldn't get away with taxing a Roth IRA. It would be a political death sentence.>>>

{{{Back in the olden days when I started my TSA at Penn State, you could take out money and just pay the taxes on it. Two years later, there was a 10% penalty added to the price of withdrawal and I believe this was a Federal tax change. Remember that high income folks don't have Roths for the most part because they couldn't contribute or convert and they all vote.}}}

"The wealthy only make up a very small proportion of the votes in America. Roth IRA contributions begin phasing out at $95,000 for single filers and $160,000 for married couples. There aren't a heck of a lot of voters in these categories. "

But the wealthy contribute a ton to politicians and certainly are benefitting hugely from the recent tax cuts, especially when comparing families without children.

Regards, JAFO

More than likely the law will be changed for future contributions rather than to take away a decade of contributions.

If you disagree, that's fine. I'm not going to argue about it.

I hope you're correct. Since I have a Roth. You hit right on when you say "It would be a political death sentence." This is way they are losing sleep over it, IMHO.

TB

FuskieFool: "More than likely the law will be changed for future contributions rather than to take away a decade of contributions."

Possibly. I agree that prior contributions will not face the FIT again because they were taxed going in, but it will be not that hard when they are desparate for revenue to say that earnings (which were never taxed) are now taxed when they come out. If you got earnings out before teh change, they would be grandfathered.

Second, as rad has already noted, means testin for eligibility for other programs is the equivalent of a potential backdoor tax.

Third, tax reform that leads to a consumption based tax (instead of an income tax) --- think FairTax, would tax the earnings when withdrawn and spent. Be careful what you wish for.

Regards, JAFO