Well hello there, let’s talk some more about your retirement!
If you read my previous post here, you know you
better be should be taking full advantage of your employer matched 401(k) account for your retirement savings. That means if your employer contributes 50% up to 4%, it is in your best interest to contribute 8% of your income in order to take full advantage.But what if you can afford a little bit more? Where should you put those dollars? Today we will be talking 401(k) vs a Roth IRA.
So what is the difference….
With a Roth IRA, you invest with money you have already paid taxes on. With a 401(k), the amount you invest is deducted from your taxable income for that year and you will have to pay taxes when you withdraw in the future (penalty-free after age 59 1/2).
But won’t I have less taxable income when I am retired?
Although your income will be less, you may also have fewer deductions (think mortgage interest, student loan interest deduction, etc). This may result in your retirement tax rate being higher than now, which makes me lean in the direction of the Roth. Also, going with a pre-tax funded account (like 401(k) is betting that taxes in general will be lower in the future, and I am just not sure that’s going to be the case.
As far a retirement accounts go, Roths are Flexible:
Retirement savings accounts are for your retirement, but life happens. With a Roth, you can withdraw what you contributed (not investment gains) from your Roth without penalty. With a 401(k), there’s a 10% penalty (possibly plus the taxes) if you make an early withdrawal. With a Roth, the money you put in is yours whenever you
want it need it, even if you are younger than 59 ½. That’s because you’ve already paid taxes on your contributions. I am not in favor of using this account as an emergency fund per say, but it is an option in case of emergency. YaknowwhatImean?
What you need to know about Roth IRA’s:
Roth IRA’s have limits
- max contribution of $5,500 ($6,500 if you’re age 50 or older) per year, or
- your taxable compensation for the year (if your compensation was less than $5,500/$6,500)
Why you should take advantage while you can
With a Roth, there is an incentive to contribute while you’re young in your career (and make less money). As you earn more money, the amount you can contribute may be affected. For 2016, if you are married and filing together, the amount of your contribution is reduced if you make more than $184,000 and is completely phased out when you reach $194,000. If you’re single, head of household, or married filing separately, that phasing out begins at $117,000 and is eliminated at $132,000. These income numbers are based on Modified Adjusted Gross Income (MAGI). More info on that calculation here. Do these numbers mean you’re out? Perhaps you can open a Roth for your teen (as long as your child has earned income, the child can use money from someone else to fund an IRA).
Is my contribution tax deductible?
Hint: you’re in luck if you’re single and make less than $61,000 or married and make $98,000 together AND/OR if you are not covered by a plan at work.
Stay at home mom or dad?
If one spouse earns income and one does not, the non-earning spouse may be able to contribute to an IRA. The total of your combined contributions can’t be more than the taxable compensation reported on your joint return. If neither spouse participated in a retirement plan at work, all of your contributions should be deductible. If one of you is covered, you may be able to contribute a lesser amount.
Still with me?
You may be worried you have already missed out for 2016, but you’re in luck!
If you open up your Roth IRA account before tax day, you get a great opportunity — you’re still allowed to make a contribution for the previous tax year.
I opened my Roth with Fidelity, it took me about2 20-30 minutes. They have a simple retirement savings comparison chart here. For the record: I am not a financial expert, just a gal with a passion for sharing my perspective and helping you live a lush life!
For more about saving money and how you can save 50k by the time you’re 40, click here.