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Should I Invest in 401k or Roth IRA?

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Should I invest in 401k or Roth IRAMany new investors wonder if they should invest in the 401k or Roth IRA. Both of these are tax-advantaged retirement accounts, but there are differences. Ideally, you should contribute the maximum to both your 401k and Roth IRA. That’s what we do. However, it’s a lot of money when you’re starting out. Some people can’t contribute that much. Which one should you invest in if you can’t contribute the maximum to both accounts? First, we’ll quickly go over the 401k and Roth IRA. Then we’ll see which one we should invest in first.

401k

The 401k is a retirement savings plan that’s usually sponsored by your employer. An eligible employee can make pre-tax contributions through payroll deductions. (Some plans have the option to contribute with after-tax income.) Here are the advantages of the 401k plan.

  • You’ll pay less tax today. Your contributions won’t be taxed and it will grow tax-free. You will pay taxes when you withdraw it later.
  • The contributions will be taken out of your paychecks. It won’t pass through your checking account so you won’t be tempted to use it. This is the easiest way to invest.
  • Many employers offer matching program up to a certain percentage of your salary. So if your employer matches 5% of your salary, then your contributions will instantly double (up to 5% of your salary.)
  • The 2019 maximum contribution is $19,000.

Roth IRA

The Roth IRA is another retirement savings account. However, you have to manage it yourself. When I first started working, I opened a Roth IRA with Firstrade because their fees were very low. They’re even better now. The online trading fee is $0 even for mutual funds! Here are some advantages of the Roth IRA.

  • You invest with after-tax money. The great thing is you will never have to pay any tax on the gains.
  • You can withdraw your contributions anytime with no tax or penalty.
  • You can invest in anything you like. Usually, the 401k has limited options.
  • In 2019, the maximum contribution is $6,000.

Read more – How to start contributing to a Roth IRA.

Early withdrawal

The beauty of these two retirement accounts is that you can use them in tandem to avoid the 10% early withdrawal penalty. They will come in very useful if you plan to retire early. You can read more about this process – Build a Roth IRA ladder to minimize taxes in early retirement.

Should I invest in the 401k or Roth IRA?

Ideally, you should contribute the maximum to both the 401k and Roth IRA. However, most new investors don’t have that much income. To max out both accounts, you’d need to save $25,000. That’s a lot of money. If you can’t save that much, then do this.

First, contribute to the 401k up to the employer matching. This is the best investment you can make because your investment will double right away. If you’re not contributing this much, you’re giving up free money. Let’s calculate and see where to invest after that. I’ll use an excel spreadsheet to do this.

Here are some assumptions.

  • The investor is in the 22% tax bracket. He can invest $6,000 in Roth IRA or $7,690 pretax in 401k.
  • 8% annual gain.
  • The investor starts at 22, retires at 60, and lives until 86.
  • The withdrawal rate is 7% at 60. I made the money run out at 86.
  • After retirement, the investor will have a lower effective tax rate due to not having a job. I assume the investor will pay 12% tax. This is a big assumption, but it should be valid. Most retirees make less money after they retire and pay less tax.

Here is the graph of the 401(k) vs Roth IRA.

Should you invest in 401k or Roth IRA?

As we expected, the 401(k) portfolio grows much more than the Roth IRA. That’s because you don’t have to pay tax initially and can invest more. The 401k grows to $1,829,768 by the time we’re 60 years old. The Roth IRA grows to $1,427,647. That’s a big difference.

Withdrawal

We need to zoom into the withdrawal period to see the differences between the two. This graph shows the income after tax.

Should you invest in 401k or Roth IRA?

We can see the 401k comes out ahead.

  • 401k: total $4,214,958 before portfolio depletion (after 12% tax)
  • Roth IRA: total $3,737,107 before portfolio depletion (after 0% tax)

That’s almost half a million dollars more if you invest in the 401k.

Why does the 401k come out so far ahead? The big difference is due to the decrease in the tax bracket. The 401k has an advantage because we assume the tax rate will be lower after retirement. I assume if you pay tax now, you’ll pay 22%. After retirement, you’ll pay 12%. That’s the secret sauce.

However, if your tax rate will be higher after retirement, then the Roth IRA will win. Some people think the tax rate will increase in the future, but I disagree. Low-income workers already struggle mightily to make ends meet. Increasing tax at the lower brackets will make life a lot more difficult for them. I think the higher tax brackets will see more change.

What if you’re in the same tax bracket after retirement

*This section is a follow up to a comment.

The 401k is clearly better if you’re in the lower tax bracket after retirement, but what if you’re in the same tax bracket? The 401k will still come out ahead due to subtlety in the tax code.

Let’s do an example of a childless family making $150,000 per year.

When they contribute to the 401k, they save 22% in taxes right away.

After this family retires, they still generate $150,000 from withdrawal. They will be in the same tax bracket as before retirement. However, their effective tax rate is 13%. Their effective tax rate is lower than their marginal tax rate. The $150,000 income is taxed at different rates as you move up the brackets.

  • 10% for $0 – $19,400
  • 12% for $19,400 – $78,950
  • 22% for $78,950 – $168,400

There is a spread of 9% in the tax rate even if they make the same amount of money after retirement. The 401k still come out ahead. That’s the difference between effective tax rate and marginal tax rate. If this is confusing, you should read up on the difference between the two.

  • Effective tax rate = total tax / taxable income.
  • Marginal tax rate = the percentage taken from your next dollar of taxable income.

For us, we should be in a lower tax bracket after retirement. Our effective tax rate will be around 7%. That’s a huge spread of 15%. I seriously doubt the tax code will change that much, but who knows.

401k first

In conclusion, it’s better to max out your 401k first then work on the Roth IRA. Most of us will be in the lower tax bracket after retirement. Assuming your 401k plan is good, it’s best to go with the 401k first. Of course, it’s best to max out both your 401k and Roth IRA as soon as you can. That’s the best of both worlds.

*The only reason to not go with the 401k first is this. If your 401k is really bad and the employer doesn’t match. In that case, you can open a traditional IRA and skip the 401k.

Okay, what do you think? I love my 401k because auto deduction makes investing so easy. It’s the best way to invest, especially for beginners. The Roth IRA is really good too. That’s why I invest in both of them.

*Sign up for a free account at Personal Capital to help manage your net worth and investment accounts. I log in almost every day to check on my investment. It’s a great site for DIY investors.

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Joe started Retire by 40 in 2010 to figure out how to retire early. He spent 16 years working in computer design and enjoyed the technical work immensely. However, the job became too stressful and Joe retired from his engineering career to become a stay-at-home dad/blogger at 38. Today, he blogs about financial independence, early retirement, investing, and living a frugal lifestyle.

Passive income is the key to early retirement. This year, Joe is increasing his investment in real estate with CrowdStreet. He can invest in projects across the U.S. and diversify his real estate portfolio. There are many interesting projects available so sign up and check them out.

Joe also highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help DIY investors analyze their portfolio and plan for retirement.

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{ 109 comments… add one }
  • marrywalker November 19, 2019, 10:33 pm

    Can you expand a bit on what you comment on in regard to those pursuing PSLF? If we are considering PSLF should we not put our money in an IRA?

  • Mannat Sharma September 4, 2019, 5:49 am

    I think my favourite part about the Roth IRA is the ease of early withdrawal. It has also made it easier to learn how investing works, without having to figure out the taxation issues.

  • Financial Samurai August 28, 2019, 8:45 am

    401(k) absolutely, Roth IRA I don’t qualify and I wouldn’t recommend it to anyone unless they are below the 24% federal marginal income tax bracket.

    You’re likely NOT going to make more in retirement than while working. Look at the logic and data!

    Sam

    • retirebyforty August 29, 2019, 10:25 am

      Exactly! The only significant risk is from the government raising the tax rate. Even then, it’ll be pretty difficult to beat the spread.

  • Myles Wakeham August 23, 2019, 7:01 pm

    Not sure I’m onboard with EITHER. I’ve been debt free since the 1990s, and I made my money investing in actual businesses – not stock market symbols. These days I practise the art of financial sustainability, and buy actual assets that yield cashflow (like real estate, vending machines, online assets, etc.). They generate more money per month than I can comfortably spend, resulting in debt free lifestyle. I’m not tied to the bull & bear markets, or putting all my faith in Wall Street to “do the right thing”. But with the upcoming recession looming, you might be interested in this article, because contrarian investors like me have a lot to look forward to:

    https://www.beunconstrained.com/article/details/i-love-recessions

    Good luck.

  • [email protected] August 22, 2019, 1:35 pm

    I think everyone who plans on retiring early should have a Roth IRA even if there is not a lot of money in it because of the 5 year rule and using a “Roth ladder” to avoid the 10% penalty if you need the money before age 59 1/2. It gives you added choices that you may want if you are going to retire early. You can convert money from a traditional 401k or IRA to your existing Roth IRA and pay the taxes when this is done. After 5 years, you can cash the amount you converted (but not the amount it earned) and not pay taxes or penalties on it.

    Also, let’s say the your individual stocks nosedives 20% or maybe just one of them does, but you believe this is just temporary, but don’t have the funds at the moment to take advantage and buy more. You can convert it to your Roth and not pay taxes on it until April. The taxes you do owe is at the lower amount.

    If you take social security at 62, then income affects your social security check more. But Roth dispursements don’t count.

    There are a lot strategies and situations that a Roth is good for especially if you retire early. I agree with the reader above that has both. I’m about 75% traditional and 25% Roth.

    • retirebyforty August 22, 2019, 8:42 pm

      Exactly! We’ll build our Roth IRA ladder when Mrs. RB40 retires in a few years. That will give us plenty of time to withdraw.
      75% traditional and 25% Roth is actually really good. We are about 80/20 right now. It should improve on the Roth side once we start converting.

  • Sarah August 22, 2019, 9:59 am

    We are nearing retirement and are now starting to put less and less in our 401k accounts and saving those dollars in a taxed account. I recently read that some widow/widowers tax bills go up after their spouse dies because they still have to take the RMD and it puts them in a higher tax bracket. They go from a married deduction to a single after two years. Some people have millions of dollars in their 401ks. They will have a difficult time either converting it to a Roth or spending it down.

    We have decided to have a balanced approach. 401k, Roths, Social Security and taxable accounts.

    • retirebyforty August 22, 2019, 8:39 pm

      That’s a really good point about widow tax.
      A balanced approach is best. We have all those as well.
      Thank you for your comment.

  • freddy smidlap August 22, 2019, 8:36 am

    we never maxed our 401k’s when we were both making kind of a lot of money but always maxed our roths. i expect to have a big nest egg in retirement where we could get hit with a higher tax rate if too much is tied up in a 401k. i would also say that if a person was interested in a mini-retirement of long career break they might want some flexibility that a roth or taxable account might offer. even though i can clearly see how the math works out i like that tax free withdrawal, especially with our high state tax rate in NY.

    • retirebyforty August 22, 2019, 9:24 am

      We have a lot in our 401k, but I’m not too worried. We’ll start converting it to Roth IRA pretty soon. By the time we’re 60, it should be at a reasonable level.
      I seriously doubt that our effective tax rate after retirement will be higher than our current marginal tax rate.

      • SusanB August 22, 2019, 3:56 pm

        The more years you can spread the Roth IRA conversion over, the more you can minimize the taxes.

        I’m in my early 60s and have been retired for over a decade. Yes, my current tax rate is much lower than when I was working. Problem is, I have so much money in my IRA (rolled over from a 401K), that I’m looking at a $50K RMD when I hit age 70 1/2. I’ll wait until age 70 to draw Social Security. Added to my pension and investment income, that’s going to push me into a much higher tax bracket.

        I’m working to convert as much as I can to a Roth IRA at lower tax rates. Fortunately, I have after-tax investments to pay the taxes. I only wish I was aware of this problem earlier and had more years to work on the Roth conversion. Instead I enjoyed several years of extremely low taxes paying 0% on my capital gains and qualified dividends.

        For those of you who haven’t, you need to estimate what your RMD will be when you turn 70 1/2. If you’ve put a lot of money into tax-deferred accounts for a couple of decades, you could find yourself with a much larger tax bill than you expected.

        • retirebyforty August 22, 2019, 8:45 pm

          You’re right! We’re in a unique position to do that. Once my wife retires, we’ll start converting our IRA to Roth.
          We’re 45 so we have plenty of time to do it. Our RMD should be very reasonable.
          Good luck! You might need to talk to a tax consultant to figure out a better way to optimize.

        • freddy smidlap August 23, 2019, 12:25 pm

          i’ve been thinking a lot about gain harvesting versus conversions and we may be getting to where the conversions make more sense and pay a little more now. i don’t think the rates will be this low forever either.

  • ThinkingAhead August 22, 2019, 8:35 am

    The key is really the assumption that you’ve made about lower tax rates in the future. Since no one really knows what their tax rates will be in the distant future, it seems like a bad idea to make that assumption.

    Run the numbers assuming that tax rates will be equal now and later and see what it looks like. That’s the apples to apples comparison that should be made, not a comparison that favors the 401k out of the gate.

    Would also be a good idea to update this post by running that comparison, as well as traditional IRA and Roth 401k options.

    • retirebyforty August 22, 2019, 8:55 am

      I’m pretty sure the 401k will win even with equal tax rates.
      With the 401k, you save at the top of the bracket. So 22% or 24%.
      When you withdraw, the tax rate will actually be lower because you’ll pay the effective tax rate.

      I updated the post with an example of someone who makes the same amount of income before and after retirement.

  • Xrayvsn August 22, 2019, 3:32 am

    Congress is thinking of eliminating this feature but as it currently stands the Roth IRA is the better vehicle if you want to pass it along to your heirs where they can do a “stretch IRA” and have the money essentially grow tax free during their lifetime as well (with a smaller required minimum distribution based on life expectancy). You can leave it to any heir that is alive at time of your death so potentially can give it to a grandchild and have multi generational transfer.

    Unfortunately this benefit is likely on the cutting block as they are looking to eliminate the stretch feature and knock it down to 10 year time frame at most.

    It is good to have some money in the ROTH side because you can withdraw money without raising your taxable income so if you are close to the next higher tax bracket (and potentially affect your social security benefits/taxable amount) you can take money out of the ROTH to live on and not bump into an undesirable bracket.

    • retirebyforty August 22, 2019, 8:56 am

      I love the Roth IRA too. That’s why I think everyone should max out both their 401k and Roth IRA.
      The Roth IRA is a lot more flexible than the 401k. It’s best to have both.

  • Andrew Kraemer July 28, 2019, 11:40 am

    I totally love the Roth so I know exactly what amount is coming back to me (all of it), but I can’t pass up on my employer matching funds in my 401(k). Thanks for sharing! I love the calculations!
    -Andrew

  • DRDACPA April 26, 2019, 12:43 am

    Great article!!! Thank you very much for sharing this detailed post on Should I Invest In 401k Or Roth IRA?. It was very helpful.

  • Kiiks March 16, 2019, 7:22 pm

    I make just under $40,000 and contribute to my 401k to take advantage of a 3% employer match. For the past couple years, I have been contributing enough annually to the 401k to keep my AGI low enough to cash in on the $200 Savers Credit (about $5,000 annual contribution). However, I’ve recently developed some big goals. I’m almost 30 and would eventually like to open a bakery/cafe down the road. However, I’d like to take advantage of my stable income now (which will certainly decrease with the self-employment) and work on big ticket items such as mortgage, retirement savings, and startup funds. I do realize that a paid mortgage may not be as significant as potential investment returns, but I am single with no option to fall back onto a second income if something happens, so a paid mortgage would be a huge sense of security for me. Any suggestions on how to be strategic about my plans?

    • retirebyforty March 17, 2019, 8:11 am

      I would save and invest in a taxable brokerage account. You’ll need a good amount to start a bakery/cafe and you should start saving now.
      IMO, you don’t need to prepay the mortgage. The interest rate is so low, you’re not really saving much.
      That’s just me, though.

  • Joel February 2, 2019, 11:02 am

    For those who have not heard of Dave Ramsey I recommend you go to his YouTube channel. Just look up “Dave Ramsey “ and everything of his will pop up.
    He’s a brilliant man and can definitely help you build wealth. Just listen to the things he says and I know you can gain great information on Roth IRA and 401k. And if you have any questions there is a number you can call him on his radio show.

  • Dan February 4, 2013, 12:15 pm

    This is very interesting to me as a CPA. I, for one, believe that it is very unlikely that you will be better off contributing to a Roth vs. pre tax 401k’s for most employed people. The reason is you take your 401k deduction at your highest rate of taxable income, say 25% for most professional single people, and withdraw the amounts at your retirement tax rates, which start at 0% and can climb to 15% or higher. However, you will need extremely large amounts of money to be taxed above 15%, particularly if you are married and your tax brackets are TWICE those of a single person.

    I have both a 401k and a Roth IRA. My wife and I have saved and invested large sums of money and I actually believe now that I may be better off putting additional investments into a Roth because I may max out my 15% tax bracket at retirement. However, my work does not offer a Roth 401k that I would like, so I simply put money into a pre tax 401k. I’d rather have this account be over funded than under funded. Over funded is an easy problem to solve, under funded is much more challenging.

    Most people should not only contribute to a pre tax 401k up to a company match, they should max this out before considering a Roth at all. At age 65, both singles and married couples also get an additional standard deduction, $1200 for one person and $2400 for a married couple, so that’s even more income, (indexed for inflation) that will be taxed at 0% when you retire instead of 25%.

  • Lee R. December 28, 2012, 12:35 pm

    I’ve been contributing to a 401(k) for over a decade but there are no matching funds from my employer. But, my question is what to do with my money since I’m within 3 years of retirement. I was considering rolling over my 401(k) to a Roth IRA but I’ve read at foxnews.com that said that I have to keep my money in the Roth IRA for 5 years before I can withdraw money from it. Also, I’m not sure if I should keep my money in the 401(k) because it’s quite possible that the Obama administration will cause taxes to increase. Since I’ll be eligible for retirement within 3 years, that wouldn’t be good for me. Also, there’s the possibility that the DJIA could drop to around 6000 again. If it’s true that my money would not be available to me, at retirement, if I put it into the Roth IRA, and since taxes are likely to go up, it seems that I should take my money out now and put it into a low interest savings account. It sure is tough to know where to put my money. I’ve even considered puting my 401(k) money into physical gold, also.

    • retirebyforty December 28, 2012, 3:17 pm

      You can check the flow chart at the end of this post for more info.
      https://retireby40.org/2011/04/retirebyfortys-investment-fundamental-6-roth-ira/
      Basically you can withdraw the contribution anytime, but you might have to pay penalties on the gain if you don’t meet the conditions.
      Your 401(k) should have a money market or bond options. Check with the plan. If you think the stock market will crash, then you can move your investment into a safer fund.
      You probably shouldn’t roll over the whole amount into a Roth IRA at once. You’ll have to pay a ton of tax if you do that in one year.
      Experts recommend moving more investments to bonds and cash when you’re near retirement. Good luck!

    • ArnieFI August 22, 2019, 8:36 pm

      Either you’re a comedian or a troll (or both). Thanks for the LOL. 🙂

      • retirebyforty August 22, 2019, 9:18 pm

        That comment was left in 2012. It’s a bit outdated now. 🙂

  • Jeanene V. October 15, 2012, 7:32 am

    I have actually taken my money out of both of my 401k and my IRA and have invested both in real estate. I know it sounds crazy, and did to me at first also, but i am making a minimum of 8% every year! Neither my 401 or my IRA came close to touching the returns I am making. Retirement here I come, in about 30 years or so 🙂 Good luck to everyone investing!

  • Jeff October 1, 2012, 6:38 am

    Can you please provide a link to the Excel file you created for this?

  • JoeTaxpayer September 29, 2012, 9:46 pm

    One large monkey wrench overlooked here – the effect of that income on your social security taxation. Just wrote about this, and it may very well put the $30k/yr withdrawal into a much higher bracket, try 46.25%.

  • Matt C July 2, 2012, 1:31 pm

    Hey folks,

    Name is Matt and I am 25 years old and just took on a 6 figure position as a pharmacist and am completely new to the investing scene. My employer matches 4% on a 5% contribution. They are partnered with T.Rowe Price and while setting up my 401k I am asked to allocate funds to things like low cap value, high value, dodge and cox, and others. I only slightly understand exactly what all of this means, but I was wondering how I should allocate my funds as well as my employer match funds. I am also considering Roth IRA on top of it all. Is that a smart idea with 7 years worth of college debt? I do not have many tax write offs as I have just graduated college and I feel maxing my investments would decrease my burden. Let me know what you think from a more professional stance!

    • retirebyforty July 2, 2012, 8:19 pm

      That’s a loaded question, but you should probably figure out what is your risk tolerance first.
      If you have high interest student loans, then you probably should prioritize that as well.
      As for the fund in your 401k. I would keep it simple and stick with index funds for now.
      Maybe 50% large cap, 20% small cap, 20% international, and 10% bond. You’ll learn more and then you can adjust it later. In the beginning, it’s much more important to start investing right away. Good luck.

  • SavvyFinancialLatina March 19, 2012, 11:33 am

    Since we are DINKs, we are going to be contributing to our 401Ks until we can get to a 15% tax rate. My plan is to increase our contribution every year until we start maxing it out, hopefully in our mid 20s. Right now we are in our early 20s. AS far as contributing to our ROTH IRAs, I’m not sure when we will start. The first thing for us will be establishing personal goals for our extra income. Like when do we want to buy a house, etc. I have thought about contributing to our ROTH IRA, and then withdrawing money for our first home purchase when the time comes. This might actually be what I end up doing. Joe did you borrow from your ROTH IRA for your first home purchase?

  • Bill March 17, 2012, 6:41 pm

    I’m 52, however I am a health fanatic and hope to live well past my 80s, even though I do have to take prescription meds, but have not stopped my insane workouts and my commitment to keeping a flat stomach. Anyhow I converted a big chunk of my tax deferred plans to Roth IRAs. Since the end of 2010 those accounts are up by 26% and I just calculated the taxes I am paying on the conversion (split between two tax years). At this point, I am ahead after those taxes still. So it was a good decision.

    I realize in the future I open up my potential places to retire simply by diversifying my tax strategy. I can retire in my native California and it won’t touch my retirement nest egg from my Roth IRAs. Some boomers I met in California are looking to retire in the Rocky Mountain states. Perhaps because their traditional IRAs gains will be taxed as ordinary income.

  • Nina March 3, 2012, 11:06 pm

    I think it might be helpful if you calculate what your tax bracket might be in retirement based on this year’s tax bracket (assuming the tax laws don’t change too much). For example, if your 401(k) is your only source of income in retirement and assuming a 4% withdrawal rate you would need to have about $2,176,500 in your traditional 401(k) before even moving out of the 15% tax bracket!!!

  • nattu March 3, 2012, 9:47 pm

    hi rb40, I never did IRA’s until now. I could get an extra refund of 1900 $ by stashing 10k in 2 traditional Ira’s right now (me &spouse) or not take the 1900 $ and lean towards roth ira’s. I feel taking the extra 19% gain right now and cumulating that money would more than cover for the tax penalty (10%?) and future income tax in the traditional IRA’. ? What am I missing here? Married filing jointly and single income we pay lower taxes anyway.

    • retirebyforty March 3, 2012, 10:46 pm

      If you withdraw after you’re 59 and a half, then you shouldn’t have to pay any early withdrawal penalty (10%.)
      It all depends on your tax rate after you retire. We don’t really know what that rate will be so if you are paying a low tax rate now, it’s better to stash the money in the Roth IRA.
      If you are paying high rate (25% or more), then I would put it in the traditional IRA to put off paying the high rate.
      Roth IRA also give you a more flexible withdrawal rate. You can minimize tax by withdrawing from both the traditional and Roth IRA.
      I’m not a tax professional so this is just my opinion.

  • Chris Barber March 1, 2012, 8:50 am

    I would rather pay the taxes now instead of when I retire only because I know at that time I’ll be on a fixed income, so I find it beneficial to pay now instead of getting caught later. However, I probably won’t have as much income when retired, so would the tax rate be less or is it the standard %15 capital gains tax?

    I checked out that 401k rollover comparison tool on FiPath and it was pretty sweet.

    • retirebyforty March 1, 2012, 9:16 am

      Any 401k withdrawal will be taxed as ordinary income, NOT capital gains. If you think you will have less income after you retired, then it’s more beneficial to pay tax later.
      Thanks for stopping by!

  • Darcie November 12, 2011, 11:28 am

    I’m a newcomer to the site, but a little confused by the debate of either/or, isn’t the max on a Roth IRA 5k/year? It seems like it would be silly to do the roth only and save so little for retirement, but I think I must be missing something…

    And for the record, my husband I max out both.

    • retirebyforty November 12, 2011, 4:53 pm

      Hello Darcie,
      Our goal is also to max out both Roth IRA and 401k contribution. Many readers are not in the position to do that and they are not sure which one to prioritize, Roth IRA or 401k.
      Most people plan to contribute to the 401k to get all the employer matching and then contribute to Roth IRA. After that, they will maximize 401k contribution.
      Thank you for visiting!
      -Joe

      • Darcie November 13, 2011, 1:32 pm

        That makes sense, thanks! I like your site.

  • gaurav October 16, 2011, 7:35 pm

    One more thing you did not mention is State Income taxes. I am in California and I would be paying 9% CA state income tax on the $16500 I wouldn’t have contributed to 401k.

    With state income tax, my marginal tax bracket is 35%. My plan is to move to state with no state income taxes i.e. Florida and Texas after retirement. This in itself would provide a 10% gain in post-retirement payout on top of the reduction in federal tax bracket.

    • retirebyforty October 17, 2011, 9:01 am

      An additional 9% in tax is quite painful. I think Nevada and Washington also has no state income tax. I’ll have to think about moving too, but the family likes it here….

  • Matt Wegner @ Financial Excellence September 25, 2011, 8:29 pm

    I prefer to take the 401(k) up to the company match where applicable, then max out the Roth. In my case I assume I’ll be in a higher tax bracket at retirement. That may not be the case but I just like the idea of not having to worry about taxes at that point.

  • Andrew @ Money Crashers September 25, 2011, 12:48 pm

    As you said, this is an age-old question. Ultimately, I would say that if you’re in a situation where you have a solid amount of funds to set aside for retirement, it makes sense to use a combination of the 2. The Roth is great because your earnings grow tax-free while also allowing you to withdraw your contributions at any time. On the flip side, if your company offers a 401k, not taking advantage of that to the max that they will match is like giving up free money. And of course you get the short-term tax benefit as well. Ideally, if you can accomplish both, that’s not a bad strategy. Great stuff on a really thoughtful post!

  • Money Reasons September 23, 2011, 6:15 pm

    Ideally my current theoretical plan is this:
    Plan Ideal
    1.) 401k (if there is a match), if no match then Roth IRA
    2.) Roth IRA
    3.) Personal brokerage account.

    But, in reality what I practice is this:
    Plan Actual
    1.) 401k (if there is a match)
    2.) Personal brokerage account.
    3.) Roth IRA

    I’m hoping once I get enough money in my brokerage account (especially dividends), I’ll switch to Plan Ideal 🙂

  • Leigh September 23, 2011, 3:07 pm

    I am in the 28% tax bracket and I have to max out my 401(k) to be eligible for a Roth. I like having the flexibility since my 401(k) is missing a couple of funds that I need to accomplish my target asset allocation. Plus, by using both of them, that’s more non-taxable room.

    I think my favorite part about the Roth IRA is the ease of early withdrawal. It has also made it easier to learn how investing works, without having to figure out the taxation issues.

  • Hunter @ Financially Consumed September 21, 2011, 5:57 pm

    I don’t have a choice, being unemployed. I max out my spousal Roth IRA. I think the answer to you question depends upon how you plan on withdrawing the funds in retirement. 401k tax considerations need to be weighed against RMD’s. I favor the Roth because of its flexibility, but having both gives you flexibility too.

    • retirebyforty September 21, 2011, 9:55 pm

      You can open a 401k and contribute any income from your blog right? I haven’t looked into this much, but it sounds like a great way to go. I’ll have to do more research and write a post on that.

  • Miss T @ Prairie Eco-Thrifter September 21, 2011, 11:33 am

    I don’t have either of these in Canada but I do have similar options to choose from. I say max them both out.

    • retirebyforty September 21, 2011, 9:53 pm

      Good call!

  • Financial Success for Young Adults September 21, 2011, 10:38 am

    Thanks for laying this all out. The 401k definitely seems like the way to go. I prefer a Roth for the potential gain because I might be able to make more trading on my own in my Roth than I can with mutual funds in a 401k. But with the employer match and a lower tax rate at retirement, the 401k seems like the way to go.

    • retirebyforty September 21, 2011, 9:53 pm

      I like Roth more for the freedom too, but I’m actually negative due to being too aggressive there. You really show contribute to the 401k up to matching. It’s guarantee 100% gain. That will be quite difficult to pull off in the Roth IRA account.

  • funancials September 21, 2011, 9:22 am

    The more analysis I see from you, the more I wish I included you in my Smart article. I contribute up to my employee match maximum (4%) and max out my Roth each year. I chose the Roth over additional 401k contributions as a house down payment fund rather than retirement.

  • 20'sFinances September 21, 2011, 6:10 am

    This is great work here! Since I am in my early 20’s, I am using both. I am investing up until the match (and a little more) in the 403(b) and then trying to max out the ROTH IRA. I will probably make more money in retirement than I am now, so I think the ROTH IRA is the best way for me to go right now. I also like that I can take out the contributions for any reason.

  • Buck Inspire September 20, 2011, 10:37 pm

    Nice analysis! I’m trying to max out my 401k, no matching though. I have a Roth going and try to max it if I have spare change.

    • retirebyforty September 21, 2011, 9:38 am

      No matching? Sorry to hear that. Hope you can take advantage of the Roth IRA!

  • Squirrelers September 20, 2011, 9:32 pm

    Both are great retirement vehicles in their own right.

    One note about taxes – who really knows what they’ll be in the future? Perhaps we’ll be taxed like crazy and the entire tax structure could be different far down the line. Maybe that could result in a higher tax rate in retirement vs now? You just never know. Thinking out of the box here…

    • retirebyforty September 21, 2011, 9:36 am

      It’s difficult to see where the country will be in 20 years. Hopefully we won’t be where Greece is today. Their tax rate is shooting through the roof…

  • Everyday Tips September 20, 2011, 7:42 pm

    My husband and I both max out our 401ks. Can’t see us being in a higher tax bracket when we retire, although who knows.

    What a great post though.

    • retirebyforty September 21, 2011, 9:36 am

      Do you also contribute to Roth IRA? It could be helpful.

  • Shaun @ Smart Family Finance September 20, 2011, 7:38 pm

    Just the 401k for me.

    Like you, I beleive my tax rate will be lower at retirement. The pre-tax benefit of the 401k allows me to contribute more principal, which in the end, will leave me a much larger nest egg.

    • retirebyforty September 21, 2011, 9:34 am

      That’s what I thought earlier, but the larger nest egg is a bit of an illusion. When we withdraw, the tax does hurt quite a bit. The difference is quite a bit less than I thought it would be.

      • Tom August 20, 2012, 1:17 pm

        The difference will increase as you contribute more per year. Your analysis was talking about 5 to 6k per year but most people here are talking about approach yearly limits.

  • Ben September 20, 2011, 3:26 pm

    The reason the Roth is better really is in the flexibility associated,including the ability to withdrawal your basis, buying your first house, and there are no required minimum distributions meaning you could pass more wealth on to your children and grandchildren.

    • retirebyforty September 20, 2011, 3:35 pm

      Roth is better for the flexibility, but I have liquidity else where. I like the no required minimum distributions since it add a lot of flexibility to my withdrawal strategy.

  • Christa September 20, 2011, 2:43 pm

    We have an IRA for all of our previous jobs, just to keep our investments straight. But we max out the current 401(k) and will continue to do so as far as I can see ahead in my crystal ball 🙂

    • retirebyforty September 20, 2011, 3:34 pm

      What about Roth IRA?

  • SB @ One Cent At A Time September 19, 2011, 7:31 pm

    I am maxing my 401(k) for now and will continue to do so, I have other investments in MFs and stocks which can cater to my liquidity needs. You cna say I am betting on tax rate keeping low when I retire.

    • retirebyforty September 20, 2011, 3:33 pm

      No investment in Roth IRA at all?

  • krantcents September 19, 2011, 7:19 pm

    I believe you will be in a lower tax bracket in retirement. Therefore invest in the 401K. To hedge my bet, I also invest in a Roth. The only advantage is no withdrawal requirement and you can leave it to your heirs.

    • retirebyforty September 20, 2011, 3:32 pm

      I agree with Krantcents. I can’t see any way that I would be in a higher tax bracket when I retire. There would have to be a huge huge change in the tax code for me to pay more tax in retirement and I don’t see it happening. I invest in Roth when I can as well.

      • Kellie February 7, 2012, 6:07 am

        In your second-to-last paragraph, you write…
        “I really doubt that your tax rate after retirement will be lower than while you are working though.”

        Sounds from your comment above like you meant to write the opposite, no?

  • Well Heeled Blog September 19, 2011, 6:27 pm

    For most folks, I think the formula would be to (1) contribute 401K up until company match, (2) max out Roth IRA, (3) go back and contribute to 401K. For 2011, I’ve maxed out my 401K – first year I’ve been able to do this! – and will max out my Roth IRA by the end of this year. I think I’ve got another $2,000 to go. I don’t get a company match. My fiance gets 10% from his employer, and he will max out his Roth IRA and then put another 5% of salary to his 401K.

    I love the Roth IRA because I get to chose where and what to put into it. I love the 401K because it’s automatically deducted from my paycheck, the limit is higher than the Roth, and it lowers my taxable income. How can I choose?! 😉

    • retirebyforty September 20, 2011, 3:31 pm

      That’s a good plan. I’d rather max out my 401k first because my tax bracket is 28%. If I was in the lower tax bracket, then I probably would invest in Roth first. I maxed out both when I was able to.

      • Kellen September 22, 2011, 7:10 pm

        Another option, if you’re in the 25% tax bracket, is to contribute enough to your 401(K) to get you down to income taxed at only 15%, and THEN switch to putting money in your Roth.

        So for single filers in 2011, the cut off between the 25% and 15% bracket is $34,500. Standard deduction is $5,800 – so if you make $43,000, your standard deduction will take you to $37,200 in taxable income. You will pay the 25% rate on your taxable income over $34,500 – so on $2,700. In this case, it might make sense to put $2,700 into the tax deferred 401(k) and avoid paying 25% on it, and then put any other savings into a Roth, since that’s only taxed at 15%.

        • retirebyforty September 23, 2011, 10:16 am

          This is a great point! I try to minimize paying the higher tax bracket as much as possible with deduction and 401k contribution.

  • 101 Centavos September 19, 2011, 5:44 pm

    Nice calcs, RB40.
    Does it matter if the funds in the Roth pay a dividend?

    • retirebyforty September 20, 2011, 3:29 pm

      I don’t think it matters if the investments in Roth pay a dividend. I have a few shares of AGNC in my Roth IRA portfolio. It’s nice to not pay tax on that dividend.

  • The College Investor September 19, 2011, 5:31 pm

    I am still sticking with my 401k. The thought of Roth IRA has not entered my mind yet, maybe in the next 6 months.

    • retirebyforty September 20, 2011, 3:28 pm

      Really? You should look into Roth IRA. As you can see from the comments, there are many fans.

  • Aaron Hung September 19, 2011, 4:26 pm

    Right now I’m just working on my 401k, I have a Roth account but not much in it because I have to take care of all my debts first. Once I’m ready, I’m gonna go full speed on the Roth because I rather pay tax now than later

  • Denise @ The Single Saver September 19, 2011, 11:27 am

    I live my life low-risk, so I do both (diversify!). I get a company match for my 401K so it would be foolish not to take advantage of that (fee money). I also assume the government will find ways to get more tax money from us as the years go on, so I contribute to my IRA now to protect myself from potentially higher taxes in the future.

  • Ashley @ Money Talks September 19, 2011, 10:50 am

    My husband’s company doesn’t offer a match, so we just use the Roth. I like that better. I don’t agree with the assumption that your taxable income will be lower in retirement. Who knows? Right now I have a lot of deductions, kids, a mortgage, business expenses. Plus, who knows what the tax rates will be in 40 years. They might be higher, they might be lower. I might have more income, I might have less income. I mean, there are a lot of variables between now and then. I feel like I have more control over the investment choices in the Roth and I know that my obligations are already paid tax wise. But again, who knows, the government might change their mind about that too.

    • retirebyforty September 19, 2011, 3:46 pm

      It’s going to take a huge change in the tax code to have my after retirement taxable income be more than my current income. Once I stop working, a big chunk of my income will disappear. I can’t see anyway that I will have more income in my retirement. It might be different if you are self employed though.

    • Joshua January 20, 2019, 8:08 am

      You also don’t know if Roth IRAs withdrawals are going to be taxed anyways in the future. it probably will not happen but I will not be surprised if they decide to tax your Roth IRA earnings when you retire.

  • Roshawn @ Watson Inc September 19, 2011, 10:08 am

    I was going to point out the assumption that your income will be lower during retirement, but you already made that point. I like your last suggestion for most people: do both 🙂

  • Chris G September 19, 2011, 8:28 am

    I like Kevin’s comment, the ability to pull out the principal before 55 gives me a warm fuzzy. Also, I think that higher tax rates in the future would be a safer assumptions. But I say why not do both if you can 🙂 Live frugal now, live like a king later.

    • David @ VapeHabitat July 16, 2018, 9:51 am

      Hi. I get $35,000/year. What am I invest in this year to have more profit?

      • Brian November 4, 2018, 12:26 pm

        Roth, by far.

  • Kevin @ Thousandaire.com September 19, 2011, 7:42 am

    The immediate liquidity of the Roth IRA makes it easily the first choice for my retirement (after the 6% matching my company gives me)

    • retirebyforty September 19, 2011, 3:42 pm

      I forgot about the liquidity aspect. I’m not planning to withdraw anytime soon so it doesn’t matter all that much to me at the moment, but situation can change.

  • Little House September 19, 2011, 6:51 am

    Great number crunching going on here. My plan next year is to max out my 403(b) (without any matching since my pension is matched instead.) If I can eek out enough for an IRA, then great. If not, I’ll just have to hope my pension fund doesn’t disappear before I retire!

    • retirebyforty September 19, 2011, 3:41 pm

      Great plan! Good luck with the pension, who knows what will happen in 30 years…

  • cashflowmantra September 19, 2011, 2:50 am

    I have been maxing out the 401(k) although did start contributing to the Roth 401(k). I currently don’t have any individual accounts.

    • retirebyforty September 19, 2011, 3:40 pm

      I contributed to Roth 401k last year, but I changed back to traditional 401k this year. I like the diversification, but I don’t like paying tax…

      • Jon -- Free Money Wisdom September 21, 2011, 7:34 pm

        I am maxing out my Roth IRA first…and still contributing to my 401k. For me, the ROTH is the way to go.

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