As I mentioned in yesterday’s article comparing the tax advantages between 401K and Roth IRA plans, I’ve decided that it is better for me to max out my 401k first before starting to invest in a Roth IRA. The deciding factor for me is that I expect to be in a lower income tax “bracket” in retirement than I am now.
Money that I put in a Roth IRA today would be taxed at my current tax rate of 28%. No matter how optimistic my retirement saving’s projections are, I don’t expect to have the same income in retirement as I do now and “theoretically” any income I do have should be subjected to a lower tax rate.
So when does it make sense to fund a ROTH IRA?
Higher Tax Rate in Retirement: Obviously, if you feel you’ll be in a higher tax bracket when you retire, its better to pay taxes now with a Roth IRA or Roth 401K than it would be to pay higher taxes later through a tax deferred retirement plan like a 401K or 403B program.
Save More: Because the limits are the same for a Roth IRA and a Traditional IRA, you can effectively save a higher percentage of your current annual income for retirement each year because $5,000 in a Roth is worth much more than $5,000 in a Traditional IRA (remember you still have to pay taxes on funds in a Traditional IRA).
401K is Maxed: If you’ve already maxed out your 401K or similar retirement account (403B, etc.), Roth IRA’s are usually the “next best option”.
Investement Option Flexibility: If you don’t like the investment options in your current 401K and you want more flexibility, opening a Roth IRA (or Traditional IRA) will give you access to a virtually unlimited number of investment options.
Everyone’s financial situation is different. The ideas and opinions about ROTH IRAs and 401Ks above relate to my own specific financial situation and are intended to give you a broader perspective of what may (or may not) be best for your specific financial situation. If you have any doubts about whether a ROTH IRA or 401K is better for you (after you invest the minimum in your company’s 401K program to get their match) be sure to speak with a professional financial advisor (I’m just some dude with a blog).
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