Why I’m Prioritizing a Roth IRA Over a 401(k)

by Darwin on March 27, 2012

Presented with the choice between maximizing contributions to either a 401(k) or a Roth IRA, many people opt for the 401(k). The prospect of “pre-tax” deductions from the paycheck is appealing since those contributions effectively reduce your tax bill each year. Additionally, the 401(k) deductions are totally on auto-drive. The money comes right out of your paycheck and goes directly to the investment firm. There’s no budgeting, there’s no check-writing or bank transfers. People find it to be convenient and automatic. Contributing to a Roth IRA however takes a bit more effort. First, you have to set it up. Then, if you don’t have automatic deductions coming out of your bank account, you need to remember to make electronic contributions or write checks. Finally, many people aren’t convinced it beats a 401(K) anyway.

  • Company Match Can’t Be Beat – First off, I don’t care how great an investor you think you are in a self-directed IRA or how bad your fees are in your 401(k) plan. If your company offers a match up to some portion of your earnings, even if just a 50% match dollar for dollar on say, the first 6%, then put in 6% minimum! Never, ever forsake a company match. You’ll never earn 50%, 75% or even the 100% that many companies offer up to a set amount in any other investment. However, after that, where is your money best directed?
  • Tax Rates Are The Key – People often assume that their tax rates are going to be higher now while they’re working than later in retirement. I beg to differ. The current financial situation in the US makes it a virtual mathematical certainty that tax rates for most Americans will be vastly higher in the future than they are now. We’re now living in the era of the artificially low “Bush Tax Cuts” that were subsequently extended by Obama to curry favor with middle-class voters. However, our deficits keep increasing our national debt by $1 Trillion or more per year and it only gets worse with a wave of retirees coming into the system. Tax rates will go up, even for the “under $200,000″ crowd. There’s talk now of increasing the capital gains rate and dividend tax rates as well. So, when I look at what my retirement income will look like in retirement, it will be a mix of social security and pension, both of which will be taxed at a higher rate than today mixed with investment income, also taxed at a higher rate.
  • Fees Matter – Even though there’s legislation due to take effect which will shine a light on company plan fees, that doesn’t guarantee that fees will ever match what you can get in say, a Vanguard IRA with expense ratios in the 0.1%-0.2%. There will still likely be higher administration fees, but now you’ll at least be able to see them. Over a few decades, the difference in fees really adds up, further favoring better returns in a Roth IRA.

If you don’t have your own IRA now and want to start a self-directed IRA where you can buy a basket of high-yield stocks or even use options for income, you should check out how you can get 100 free trades for starting up a self-directed IRA. The way I run mine, I have several stocks yielding about 7% as a mix. Regardless of what kind of stock price moves I see in the portfolio, as long as they maintain (and often increase) their dividends, I’m earning a 7% return tax-free which keeps getting rolled into new shares.


What Are Your Thoughts on 401(k) vs. Roth IRA Prioritization?

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