Difference between Roth 401(k) and regular?
I could use some help here, people. I know the difference has to do with how they are taxed and when, but which one is better for me, and why? I am 32 years old and just beginning this plan. I am in a low tax bracket already, with an anual salary of about $12,500.00 gross income. Any advice for me?
Roth is post tax income
401k pre tax
You’re still pretty young, so do a Roth IRA. Right now you can put as much as $4,000.00 into a Roth IRA per year (that’ll go up to $5,000.00 in 2008), but the difference is you don’t pay any tax on the money you invested when you cash it in — you’ll only pay tax on the interest you earned. Not the case with a traditional IRA — you pay tax on EVERYTHING.
I asked this same question, this is the perfect answer I got I chose it as my best answer:::
What is the difference between a Roth IRA & an IRA & how do I roll my 401k into one of these?
To roll it over you should talk to an investment professional like a financial planner or visit a website like vanguard. Whoever you speak to should be quite thorough in asking you about your goals, timeframe, and what you envision for your future. You should do your homework and find out how they are compensated (high fees can crush your returns). Choose someone with at the very minimum 5 years of experience (if you choose to work with a professional), and preferably a CFP designation. If you want to go it alone, the information you seek is readily available on the internet and in various literature, but you need to be prepared to invest the time needed to educate yourself properly.
An IRA (individual retirement account) is pre-tax money, the IRS hasn’t taken it’s share out of this yet, just like your 401k. If you roll your 401k into an IRA, it won’t be taxed. The money accumulates tax free, and when you withdraw the money, the IRS takes its share. The idea is that in retirement, your income will be in a lower tax bracket so when you withdraw the cash, it will be a lower percentage than when you earned your paycheck. In addition, since the money goes in pre-tax, you can earn returns on all those dollars that would have gone to the government. The thing is, when those earnings come out, they’re ALL taxed. Generally, if you withdraw from an IRA before the age of 59.5, there is a 10 percent early withdrawal penalty in addition to the IRS income tax (which sucks, avoid this if possible). After the age of 70.5, there are mandatory distributions, which means you have to take money out every year (which also sucks because this could bump up your income to a higher tax bracket)..
With a Roth IRA, the money that goes in is after tax money (already paid uncle sam). The money accumulates tax free, just like the IRA. There is also the 10% early withdrawal penalty (there are exceptions like 72T extension but you should talk to a financial professional for more detailed info, or ask the Oracle named google). When the money comes out, however, everything is federal tax free. In addition, there is no mandatory withdrawal. Also, you can pass a Roth IRA on to your beneficiaries tax free, they do not have mandatory withdrawals either. What sucks about this that if you roll your 401k into your roth IRA, you will pay taxes on everything in your 401k as it goes into the Roth.
Regardless, you have 60 days from receiving your 401k check to roll it over (NOT 2 MONTHS), otherwise you get nailed for 10% for withdrawing early. So if you have the check already, you’d better get moving.
Roth 401K contributions are “after tax” dollars, so when the time comes to withdraw them, there is no tax to be paid. A regular 401K plan the contributions are “pre-tax” when you withdraw the money you will pay tax at your marginal rate.
I recommend the regular 401K for your current situation, contribute as much as you can afford, and try to at least contribute as much as your employer will match.
good luck
Roth IRA is funded with “after-tax” money. What that means is that you pay taxes on your income and then you put a portion of what is left into the IRA.
A Traditional IRA is funded with “pre-tax” money. That means you put money into the IRA before taxes are taken out of your income.
In addition to this difference, when you take the money out, you pay taxes on it if is was in a Traditional IRA but you dont pay taxes on it is it was in a Roth IRA.
As for your particular situation, I suggest the Roth IRA. It is likely that your current tax rate is far lower than what your tax rate will be when you retire.
A good way to determine what is best for you is to look at your current imcome and what you think you will be making when you retire. Then take the amount you think you will be making when you retire and take 75% of that (most people agree that they will need 75% of their income level at time of retirement to live on each year during the retirement years).
Here is a simplified example. You make 12.5k a year now. By the time you retire, lets say you will be making 40k. Take 75% of 40k and get 30k. Now, your tax rate will be higher on 30k than on 12.5k so you will benefit more by getting taxes now rather than later.
Hope this helped.