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Question for the Money Doctors

Question submitted on Oct 17, 2013.

Question

Hey I got a question about retirement accounts. I have been with my employer for 5 years and am enrolled in the company''s 401k plan. I contribute 6% of my pay towards that each week. I recently learned along with my 401k that I have a Roth IRA account that I have a bit of money in, but am not currently contributing towards. My question is: would it be more advantageous to increase my contributions with my 401k or contribute towards both? I am currently working more and earning more, so I am looking to contribute more towards my retirement. Keep in mind, though, I am only 25. Thanks for your time.

Answer

Thank you for the question. It sounds like you are ahead of many of your peers if you are investing at such a young age - congratulations. I would recommend meeting with a qualified professional to do a comprehensive financial plan at some point someone like a CPA Financial Planner will help you put all the pieces together and determine the amount you need to save.

In general terms, the main difference in a Roth IRA and a 401k is when the money is taxed. A 401k give you immediate tax deferral, but you pay the taxes when you take the funds out (and a penalty if you withdraw before age 59 1/2). A Roth IRA is the opposite - you pay the taxes now, and then take the funds out tax free. The big question is, what is your tax rate now (you should be able to figure that out) and what will your tax rate be at retirement? Who knows what that rate will be. If you feel that taxes in general or your tax bracket will go up by the time you retire, then you should tilt more to the Roth IRA. If, however, you think taxes or your rate will go down, then put more into the 401k. Of course, company contributions play a role in this decision. The 6% you are currently putting in may be maxing out what your company will match, but that is something to check out if you don''t know. Either way, the amount you put away will have a much greater impact than what vehicle you choose to use. If you can do at least 10% of your income (and preferably more), then you should be in pretty good shape regardless of whether you do the 401k or Roth IRA.

I hope this helps.


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