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Roth Ira 401k - Roth IRA or 401(k)? It depends on what your goals are.

contributions tax account individuals

Both the Roth IRA and 401(k) are individual retirement accounts established under IRS tax rules. The programs are designed to encourage individuals to save for their retirement by offering them numerous tax benefits for putting money into these specialized accounts. Though the high-level objectives of the Roth IRA and 401 (k) are similar, the way the two programs operate are very different. For instance, the manner in which the contributions are taxed in each case is very different. Similarly, the withdrawal rules associated with each program is different and so is the manner in which penalties are accessed. The maximum amount of money that an individual can contribute to these accounts every year also is vastly different, especially in the case of those with above-average incomes.

One of the biggest differences between a Roth IRA and a traditional 401(k) account is when the taxes are paid. In a 401(k) account, an individual’s contributions to the plan are completely tax deductible. In other words, no taxes are paid on the contributions that an investor makes into his or her 401(k) account. The money is allowed to compound tax -free in the 401(k) account until it is withdrawn, at which point the investor pays taxes on the contributions and on the earnings. In direct contrast, the contribution that is made into a Roth IRA account is money that the investor has already paid ordinary taxes on. Here too, the money is allowed to compound tax-free but it this case, it can also be withdrawn tax-free by the investor so long as certain requirements are met.

Another crucial difference between the Roth IRA and 401 (k) is the fact that the Roth IRA does not require individuals to start withdrawing money from their retirement accounts once they reach a certain age. In the case of the 401 (k), investors must start taking money out of their accounts at age 70 ½ whereas with a Roth IRA an investor need not touch their accounts in their lifetimes if they choose to and can instead pass it on to heirs and benefactors if they wanted.

The rules associated with early withdrawals are also substantially different between the two retirement accounts. In the case of the Roth IRA, individuals are allowed to withdraw their own contributions into the account at any time, without any penalties or fines. However, the earnings on those contributions can attract a 10% penalty and ordinary income tax if certain conditions are not met. For instance, individuals need to be at least 59 ½ years old, and the Roth IRA account has to be at least five years old, for an individual to be able to make a tax-free withdrawal of the earnings in a Roth IRA. Roth also allows individuals to make tax-free withdrawals if the money is going to be used to purchase a first-home, or to pay off medical bills. With a 401(k) plan, non-qualified withdrawals automatically attract a 10% penalty and are subject to all applicable taxes. Individuals do not have the option of withdrawing just their contributions like they can with the Roth IRA.

Both the Roth IRA and the 401(k) have limits to the annual contributions that can be made into the accounts. The limit in 2010 for Roth IRA is $5,000 for individuals aged 49 and under, and $6,000 for those who are 50 years of age or older. Under the 401(k) plan individuals can contribute up to a maximum of 10% of their annual salary, or $5,000, whichever is lower. Roth IRA and 401(k) plans differ in the manner in which contributions are managed. An employer typically manages a 401 (k) plan and the employee agrees to have a portion of his or her pay automatically deducted at source at invested into the 401(k) account. In many cases, the employer contributes to the plan on behalf of the employee. With a Roth IRA, an individual makes all the investments into the account in many cases, and there is often little direct participation by the employer.

For many though, the main difference between the two really comes down to when the contributions are taxed. Individuals that foresee having to pay more taxes towards the end of their careers compared to what they are paying now might benefit from a Roth IRA because their contributions are taxed at current rates. On the other hand, those who foresee downsizing on their careers or paying less in taxes in future might see greater benefit with a 401(k) plan.

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