YOU ASK:

401k vs Roth IRA – which is the better retirement option?

WE ANSWER:

The decision will depend on your specific personal financial situation. If you expect to be in a higher tax bracket prior to retirement, you are better off going for a traditional 401k plan which will defer your taxes while you are working until the time you retire.

Contrary, a Roth IRA will be beneficial to individuals who prefer paying taxes on their contributions while they are working, and then receiving the Roth IRA distributions free of income tax.

The New Retirement Plan - Roth 401k

The good news is that a new retirement plan has been introduced as an alternative to traditional 401k, combining the advantages and eliminating some of the drawbacks of both 401k and Roth IRA plans. The Roth 401k is, in fact, so attractive that there have been discussions about completely replacing traditional retirement plans.

Here are some characteristics of the Roth 401k:

  • Modeled after the Roth IRA, the new Roth 401k plan is funded with after-tax dollars, i.e. investors pay income tax on their contributions but after they reach age 59.5, any withdrawals or qualified distributions are tax-free.
  • Income limitations that are imposed on participants in Roth IRAs, do not exist under a Roth 401k. Besides, investors can contribute to both a Roth 401k and a traditional 401 k. Contribution limits, however, remain the same: for 2009, it is $16,500 for people under age 50, and $22,000 for people over 50.
  • Unlike Roth IRAs, Roth 401k plans require their participants to take distributions after age 70.5, regardless of whether they would want to. A rollover to Roth IRA, however, can help you avoid the Roth 401k minimum distribution requirement.
  • Assets from a traditional 401(k) plan cannot be converted into a Roth 401(k).
  • As of 2010, the $100,000 modified adjusted gross income restriction for people wishing to convert to a Roth IRA, will be repealed, thus making Roth IRAs more widely accessible. Another major change which was introduced in 2006, allows participants in employer-held retirement plans to designate salary deferral contributions to 401k and 403b plans as Roth contributions.
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