Should I Invest in a 401k or Roth?

Choosing the right type of retirement plan can make a big difference in the amount of money that you are able to save for retirement. Two of the more popular options are a 401k and the Roth IRA. When choosing between them, you should consider the tax status of each account as well as the maximum contribution limits.

401k

• A 401k is a type of retirement account that is offered by employers as a benefit to employees. With a 401k, you set aside money on a pretax basis from your paycheck. The 401k allows you to put this money into investments that are available through the plan. The returns from investing grow tax-free. Then, when you reach 59½, you can access the money from your account, and you will pay taxes on it at that time.

Roth IRA

• The Roth IRA is a type of retirement account that you set up on your own. It is not set up through an employer but is managed by the individual account holder. With this account, you contribute money to it on an after-tax basis. Unlike a 401k, you are not limited to only the investments offered by an employer's plan. The money that you make from investing is tax-free. Once you reach 59½, you don't have to pay taxes on your withdrawals.

Contribution Limits

• One of the big differences between these two types of retirement accounts is the amount of money you can contribute. You can contribute considerably more to a 401k than to a Roth IRA. As of 2010, you can contribute $16,500 per year to your 401k, or $22,000 per year if you are over 50. With a Roth IRA, you can contribute only $5,000 per year, or $6,000 per year if you are 50 or above.

Income Limits

• Another difference between these two types of accounts is the income limits. With a 401k, anyone can contribute to the account. With a Roth IRA, there are income limits that must be followed. For instance, if you are single, you have to make less than $105,000 per year to make a full contribution to a Roth IRA. If you are married, you have to make less than $167,000 per year to make a full contribution.

Considerations

• One of the most important factors to consider is when you want to pay your taxes. If you use a 401k, you have to pay the taxes on the back end, when you retire and make withdrawals. This can create some uncertainty, because you may not know how much your tax rate will be at retirement. With a Roth IRA, you can get the taxes out of the way now, when you know your tax rate.