Many of us face a dilemma: Should I invest in a Roth IRA, my 401k plan, or a Traditional IRA or some combination? Here are some simple rules of thumb:
If you employer matches your 401k contributions:
- Invest in your 401k up to the amount to get the maximum match
- Then invest in a Roth IRA if you are eligible
- Then invest in your 401k again (no match)
If you employer does not match
- Invest in a Roth IRA if you are eligible
- Invest in your 401k
The situation is more complex if you are not eligible to contribute to a Roth IRA with many contingencies that are best handled on a case by case basis. Also, if your employer has a high cost 401k plan you may actually be better off investing some of your funds outside of your 401k in a regular taxable account once you have invested enough to receive the maximum 401k match.
The reason why Roth IRA contributions are a better bet for most people vs. a regular 401k contribution include:
- Tax rates are likely to be higher than they are today in the future when you withdraw your 401k contributions.
- You will have Required Minimum Distributions from a 401k plan at age 70-1/2.
- Your heirs will required to take distributions from your 401k plan and pay taxes on them. There are no required distributions from a Roth IRA and any distributions are tax free.