A Roth vs. 401K. Who wins? Surprisingly, neither! That's right, they both lose, and for different reasons. When you consider investing in either a Roth or a 401k, you have to consider what you are trying to do. In a few of my other posts, I've discussed why traditional 401ks make for terrible investment solutions.
Just to recap: if you plan on doing well, then a 401k will have you paying back more in taxes than you saved. Forget about the employer match for a moment. Focus on one of the "truths" being hammered into your subconscious mind for a moment. What do we continually hear about retirement? We hear that we'll be in a lower tax bracket. THINK about that for a moment. If that were true, and it could be if you are not saving very much money, it means that you are making less money than you are now. Factor in inflation and it's not a pretty picture.
What I'm trying to say in plain English is that if you are in a lower tax bracket it's because YOUR BROKE! Do you want to be poor in retirement?
Now...there is the other side of the debate on this one. The Roth IRA. The Roth is an interesting creature. It allows you to contribute after tax dollars in exchange for tax-free retirement income. What's wrong with that? Nothing...except the contribution limits. That, and if you make a decent 6 figures, you're never going to see a Roth in your retirement dreams.
The Roth vs. 401k debate is really about which Government sponsored retirement plan is the best. What about non-Government sponsored plans? What about paying (lower) capital gains tax instead of ordinary income tax? What about using insurance policies which are excluded from taxation (and for perfectly legitimate and different reasons than for a Roth)? What about avoiding all or most of the government rules. restrictions and penalties surrounding retirement plans? It's your money, use it when you want to (wait, I know, I'm stealing this line from somebody aren't I?).
In the end, I think there's much more to think about than "what government tax favor should I use?"
Weird, I met with the manager of my bank branch a couple months back. While I can’t recall the specifics, I do remember him really pushing Roth over the 401k. Granted, I suppose he has various reasons for that, but still.
Yes, recommending government plans is very common. It’s very often considered the only “real” solution to saving money for your future. The tax-free income is the biggest benefit for the Roth and contributions can be removed at any point after you put money into your account.
My biggest problem with Roth IRAs is that they are government favors. And, like all government favors, they can change the rules whenever they want. We’re seeing this in 2010. Although this one seems to be beneficial for many investors, there’s nothing to say that it has to be.
The unattractive provisions of a Roth are the one’s that make it “work” like penalties for early withdrawal of earnings and the contribution limits. It also creates very subtle market distortions because of the fact that it provides special tax favors to middle class Americans by barring access to the upper income individuals and families.
Private contracts don’t do this.