Here’s a topic that’s been coming up a LOT recently, and this is an extremely confusing decision: What’s better to invest in - Roth IRA or a Traditional 401k? Here’s my thoughts, enjoy! Add me on Instagram: GPStephan
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So lets first start with some background on the almighty Roth IRA:
First, like I just mentioned, all of the profit generated in this account is tax free after the age of 59.5. That could save you a LOT of money by the time you retire, especially if you begin investing in this early on.
Second, with a Roth IRA, you can withdraw whatever money you contribute to this account, at any time, tax free, without paying any penalties.
However, here are the downsides:
First, with a Roth IRA, you contribute POST TAX MONEY - this means the money that’s left over after you’ve already your paid taxes on it. And as we all know, the money you have left over AFTER taxes is a LOT smaller than before the taxes were taken away…this means you’ll have LESS of your money to invest upfront, all things considered.
Second, if you want to withdraw your PROFIT from this account before the age of 59.5, you’ll be subject to a 10% penalty, and you’ll have to pay normal taxes on that profit.
Third, the contribution limit for a Roth IRA is capped at $6000…so if you want to contribute more than this, well, you can’t.
But how does this all compare to the Traditional 401k?
Well, the 401k is an employer sponsored retirement account where you contribute PRE TAX money…meaning you won’t pay any taxes on the money you invest in this account. Now because you don’t have to pay taxes on the money you contribute, you have even MORE money left over to invest instead of paying it to the IRS, allowing that extra money you saved in taxes to make YOU even more money.
Pros of a Traditional 401k:
You contribute pre-tax money, meaning you don’t pay taxes on the money you put in this account, and can be a huge tax deduction.
Secondly, you can contribute up to $19,000 per year in a 401k…that’s more than 3x HIGHER than you can contribute to a Roth IRA.
Third, some employers offer a 401k employer match - which means they actually match your contribution, dollar for dollar
Downsides to the traditional 401k:
The first is that you’ll end up paying taxes on your money when you begin withdrawing it from your account after the age of 59.5. With a 401k, you’re basically saving money on taxes NOW so you have more to invest upfront.
Secondly, if you want to withdraw the money prior to the age of 59.5 for anything other than financial hardship, you’ll be subject to paying a 10% penalty on your money and you’ll owe taxes as though this money is ORDINARY INCOME.
Third, you’ll be forced to begin withdrawing your money at the age of 70 1/2…and for some people who prefer to continue saving it and letting it grow, well…you can’t.
And the right mix is - in my opinion - a slight balance between the two. I still contribute a bit to my traditional 401k just to hedge my future options, even if I have no idea if it’ll be the smart choice in the future…again, JUST IN CASE. I also go heavy on the Roth option, too, because I know it’ll be tax free in the future, and I don’t have to question what future tax rates may or may not be.
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