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Usually, it is advisable to prefer a 401k over a Roth IRA. Once you have invested in the former, an amount that suits your employer, you can go ahead with investing in the other account. If you are left with surplus funds even after making maximum investment in Roth IRA, you can proceed to max out the 401k account and other taxable accounts. However, as every case is unique, there are a number of ways in which one can go about investing the funds.
Following are a few points to determine what is better for retirement funds, Roth IRA or 401K:
- Matching contribution is provided by employers in case you choose to invest in the 401k plan of the company. However, no such contribution is offered if you invest in Roth IRA. Hence, if your expenses are high or your investment plan is not the best one, you can take advantage of the ‘free money’ made available by the employers in retirement plan, like 401k, sponsored by the employer.
- However, if you are looking for a wide range of investment options, Roth IRA is anytime better than 401k. While majority of 401k plans offer a restricted number of investment options, the Roth IRA offers unlimited investment options, ranging from mutual funds and banks to brokerages.
- The amount invested in a 401k account is tax-deferred; while that invested in Roth IRA account is absolutely free of tax. Thus, if you are expecting to fall in the high tax bracket upon retirement, your Roth IRA contributions can help you save substantially on tax.
- Opportunities for tax planning under the RMD (Required Minimum Distribution) rules are available only if the person has a Roth IRA account, with or without a 401k plan.
- While the Roth IRA earnings are subject to tax-free and penalty-free withdrawal at any point of time, early 401k withdrawals are usually not permitted.
- If you feel that you cannot afford to be disciplined in your investments, prefer a 401k plan over Roth IRA as the latter does not necessarily offers the option of automatic investment contribution and requires a lot of effort from your side.
Thus, every circumstance is completely different from the other. The choice of investment plans and the order in which the funds are contributed into various accounts depend entirely on your budget and requirements. Ideally, using a mix of both the accounts is the best strategy for majority of the people as it gives a lot of planning opportunities and flexibility in taxes and withdrawals.
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