There are way too many numbers and not enough vowels when it comes to retirement account names. This can lead to you thinking – WTF! Or at least that’s the thought that crossed my mind.
Luckily the breakdown is much easier to understand than the names may suggest. Like most things in finance, there are pros and cons to both types.
Let’s break each type of account down and maybe that can give you more insight into where you should be investing your money.
Nearly everyone has heard this term, and most people know that it is a retirement savings fund. This is the most common type of account, originating nearly twenty years before Roth started – Making it much more well known than its counterpart.
Your 401K is funded with pre-tax dollars, in turn lowering your taxable income. This also means that you must pay taxes on any withdrawal you make after you retire.
There is also a certain convenience in the fact that it automatically comes out of your paycheck and there is no income limit.
You can contribute an annual $18,000 a year.
This is a more recent concept that not everyone knows about. Starting in 1997 people began able to contribute a portion of their income into what is called a Roth IRA.
This type of account is funded with after tax dollars and lowers your taxes in retirement, due to the fact that you have already paid said tax. So any money you withdrawal after retirement is tax free.
In this type of account you must make your own investments, as opposed to the automatic withdrawl convenience of 401K. There is also an income limit of $118,000, making this more convenient for younger workers, just starting out in the real world.
You can contribute an annual $5,500 a year.
So which is better for you? It comes down to what you think your interest rates may be when you retire. Will they be higher? Then Roth may be the better option. But what if its lower? Then 401K is the way to go.
However there is no way to know what the future will hold. So Where does that leave us? Well, many financial advisors will suggest first maxing out your 401K and then investing extra into Roth.
However when you are younger it may benefit you to invest more heavily into your Roth due to the large amount of tax free income you will be able to acquire before retirement.
As an axample, I currently invest a combined 30% of my paychecks to retirement – Half in each type of account. This gets me extremely close to the maximum I can invest each year and I feel as though I am making strides in both of my accounts.
This all comes down to what you feel comfortable with. Do what you feel will benefit you in your financial future. You know yourself better than anyone else, trust your gut and just be sure you are investing in something as early as you can!