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  • Roth IRA vs 401(k)

    Posted on August 13th, 2010 William No comments

    There are a great number of different retirement plans out there, but the two most common are the 401(k) and the Individual Retirement Account (IRA); each have their advantages and disadvantages. There’s a good chance that you want to have both!

    401(k):

    A 401(k) plan is an employer-sponsored retirement plan funded with pretax dollars. Simply fill out a form and a set amount or percentage will be automatically deducted from your paycheck each month; you do not pay taxes on your contributions, or the earnings on your investment, until you withdraw the money. When you withdraw, it is taxed at your ordinary tax rate. The contribution limit for 401(k)s is $15,000 for 2006 and $15,500 for 2007.

    Advantages of a 401(k):
    It is funded with pretax dollars, which means you earn interest on money that would normally have gone to taxes
    Many employers will match your contributions up to a preset limit, effectively doubling your contribution

    Disadvantages of a 401(k):
    In most cases, the money cannot be withdrawn before age 59½ without severe penalties
    You have to pay taxes on your withdrawals

    Roth IRA:

    There are several types of IRAs, but we will focus on the Roth IRA, which is funded with after tax dollars. While contributions are made with income that has already been taxed, Roth earnings are tax-free, and you may withdraw up to your total contribution at any time. The maximum contribution towards all IRAs is $4000 per year for 2006 and 2007, $5000 per year in 2008; contributions must be made with earned income. As with the 401(k), earnings may be withdrawn without penalty in the tax year the participant reaches the age 59½.

    Advantages of a Roth IRA:
    Contributions can be withdrawn at any time
    Earnings are tax-free

    Disadvantages of a Roth IRA:
    Earnings are taxed before they can be contributed
    Relatively low contribution limits

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