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Hi all!

I am currently contributing 14% of my salary to my 401(k) plan; my employer matches 4%. We are not contributing to any IRAs at the moment. From what I can tell, we qualify for contributing to Roth IRAs but not for traditional IRAs.

My wife and I have recently received or read several recommendations that we reduce our 401(k) contribution and fund Roth IRAs.

From a wealth accumulation point of view, is this Wise? Or Foolish?

I decided to do a very simple analysis in Excel, and from what I did it came up an absolute wash. Since most Roth vs. traditional IRA calculators on the WWW have indicated to me that a Roth is the better choice, and since traditional IRAs and 401(k)s act similarly with respect to tax treatment in my case (I'm 29 and all of this money is for retirement), and since everyone is saying do the Roth, I was surprised at my analysis.

Here's what I did:

I started off with a one-time $2000 contribution this year. I assumed I'd pay 28% tax on the money going into the Roth, so I subtracted that off the top and invested the balance ($1,440, I think) into the Roth in column A. In column B I stuck the whole $2000 into my 401(k). I assumed a 10.5% annual rate of return for both (I would put both in an S&P 500 index fund; I would not at this point put the Roth into the Foolish 4). I then compounded for 36 years until age 65. I then took the balance in the 401(k) and subtracted off the 28% tax there. The resulting amount was precisely identical to what was in the Roth. (After I thought about this for a while, it made sense.)

What am I missing between my analysis and everyone else's?

I do understand that if my tax bracket increases in retirement that the Roth is a better deal. I am not convinced it will in my case.

I also understand that I have more investment choices with a Roth. Fortunately, I like my choices in my 401(k).

I also understand there are different features to Roths versus 401(k) having to do with distributions and estate stuff, and house withdrawals, etc. These are a secondary concern to me now.

Finally, I suspect that everyone's suggestion that I fund a Roth is simply a way to get me to open an account with them and then eventually get a shot at servicing my brokerage account, checking, and savings, thus gaining whatever revenues there might be there. Kind of like my local bank screaming at me to get a home equity line of credit and pay of those nasty credit cards...

Any help understanding this would be appreciated.
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My wife and I have recently received or read several recommendations that we reduce our 401(k) contribution and fund Roth IRAs.

From a wealth accumulation point of view, is this Wise? Or Foolish?


Max out both.

I started off with a one-time $2000 contribution this year. I assumed I'd pay 28% tax on the money going into the Roth, so I subtracted that off the top and invested the balance ($1,440, I think) into the Roth in column A. In column B I stuck the whole $2000 into my 401(k).

When you run the figures like this, the only difference is in your tax rate at retirement. The reason must calculations show the Roth as better than the regular IRA, is that you effectively get to invest more in a Roth. In this sense you can't really equate the regular IRA to a 401(k), since the latter allows you to invest a lot more.

I started to type an explanation, but I can't explain it as clearly as Kat has done, so I'll simply provide a link to his web site: http://www.fairmark.com/rothira/index.htm
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Greetings, Malakito, and welcome.

My wife and I have recently received or read several recommendations that we reduce our 401(k) contribution and fund Roth IRAs.

From a wealth accumulation point of view, is this Wise? Or Foolish?

I decided to do a very simple analysis in Excel, and from what I did it came up an absolute wash. Since most Roth vs. traditional IRA calculators on the WWW have indicated to me that a Roth is the better choice, and since traditional IRAs and 401(k)s act similarly with respect to tax treatment in my case (I'm 29 and all of this money is for retirement), and since everyone is saying do the Roth, I was surprised at my analysis.


You discovered that when all is even on a tax-equivalent basis and in returns, then there is no difference. Do read KAT's Board on the Roth that Nizac mentioned. Additionally, I encourage you to read the analysis I posted in this folder at http://boards.fool.com/Registered/Message.asp?id=1040013000441002&sort=postdate . Both references will give you some perspective on the matter.

Regards…..Pixy

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Others have mentioned the analysis in my web site so I'll just make a couple of very brief comments. First, much of the benefit of the Roth IRA goes away if you reduce the amount of tax-favored savings by the amount of tax you pay on the contribution. One of the main benefits of the Roth IRA is to allow you to increase the amount effectively invested in a tax-favored vehicle. If you neutralize that advantage, there are still some other advantages (mainly greater flexibility both in taking money out before age 59½ or and leaving it in after age 70½) but they won't show up in the kind of numerical analysis you're doing.

Second, I have a page that describes some other considerations specific to choosing between a 401k and a Roth IRA at http://fairmark.com/rothira/rothvemp.htm .

Kaye Thomas, author
Fairmark Press Tax Guide for Investors
http://www.fairmark.com
Includes guidance on the new tax law
and a new Guide to AMT
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As you can see it is hard to forcaste the future.
I think you have a reasonable command of the facts.
Your answer will not depend on the projected financial results but on what may happen in the future to the tax laws and your pre retirement unexpected cash needs. I would go with the Roth. Sort of like asset diversification or don't put all of your eggs in one basket. By the way, after your next raise you may want to increase your 401k contribution and max out both the 401k and the Roth.
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