How to Balance Savings Between a 401(k) and Roth IRA

If you have both a 401(k) and a Roth IRA, you may wonder which is the preferable way to add to your retirement savings. As a first consideration, if your employer offers a 401(k) plan, be sure to obtain the entire amount of the company’s matching contributions. Beyond the amount your employer matches, you may want to consider your Roth IRA rather than adding more to your 401(k).

In contrast to a 401(k) plan, a Roth IRA will provide you with much flexibility during your retirement years. While a 401(k) plan consists of pre-tax dollars that grow on a tax-deferred basis, and require you to pay tax upon making withdrawals prior to turning age 71, a Roth IRA is made up of after-tax dollars that grow on a tax deferred basis for the remainder of your and your spouse’s lives; there are also tax benefits for your heirs. You can make withdrawals from the principal without being subjected to penalty or tax. 

However, when investing in a Roth IRA, you do not benefit from the immediate tax deduction that you receive when you have a 401(k) plan. But as tax rates increase, your Roth IRA is likely to be more valuable than the 401(k) because it will be unchanged by the rise in taxes. 

Once your Roth IRA is fully funded, if you can afford to save more, you could put more in your 401(k), or  you could open a taxable brokerage account in which you invest in stocks and stock mutual funds. Following a one-year holding period, these funds are taxed as capital gain, for which the tax rate is likely lower than the ordinary income tax rate to which your 401(k) distributions are subject.

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