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Roth vs. 401(k)
My company doesn't match contributions to my 401(k). Should I put my money in a Roth instead?
March 11, 2003: 11:04 AM EST
By Walter Updegrave, CNN/Money Contributing Columnist

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I participate in my 401(k) at work, but my company doesn't match any of what I contribute. I'm considering dropping out and doing a Roth IRA instead. Do you think this is a wise course of action?

-- William Moebs, Gasport, NY

Gee, what a shame your employer is being so chintzy. Most 401(k) plans offer at least a partial match. Maybe a short polite memo to your human resources department signed by a group of employees would help -- hey, it couldn't hurt.

Until then, there are a few things to consider.

Which tax bracket will you end up in?

With the 401(k), you're investing pre-tax dollars (an immediate tax break), and then pay tax when you withdraw your money. With the Roth, you forego the immediate tax break but pay no tax upon withdrawal.

Assuming the same returns, generally, you're better off with a 401(k) if you expect that you'll be in a lower tax bracket at retirement. The reason is that you will be avoiding taxes on your contribution and your earnings at a high rate and then paying taxes at a lower rate when you withdraw your funds. In effect, you're arbitraging tax rates.

If you expect that you'll be in a higher tax bracket later in life when you withdraw the money, then you're probably better off in the Roth.

If you expect to be in the same tax rate, then it's pretty much a wash. A match almost always tilts things in favor of the 401(k).

Some people have a hard time believing that this is the case. So if you would like a specific example that compares the growth of the same contribution in both a 401(k) and a Roth IRA at various tax rates, click here.

There are some other factors

But there are other factors to consider. Once you reach age 70 1/2, you've got to begin withdrawing money from your 401(k) account (or, as the case may be, from your IRA rollover account, since many people eventually transfer their money from a 401(k) to an IRA rollover).

If you fail to do that, or if you withdraw less than the government-mandated minimum, you could be hit with a sizeable tax penalty. Meeting the IRS's required minimum withdrawals isn't a problem for most people, since they need money from their 401(k) to live on during retirement.

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But if you think you would like to leave some of the money in your retirement accounts to heirs, then a Roth IRA could be the better bet. There are no minimum withdrawal requirements for Roth IRAs. You can let the money compound tax-free as long as you like.

Remember too, though, that there are some practical matters you should take into account -- namely, will you be able to save enough by contributing to a Roth alone? You're now limited to a $3,000 maximum contribution to a Roth IRA, although that maximum rises to $4,000 in 2005 and then to $5,000 in 2008, after which it's adjusted for inflation. (If you're 50 or older, you can also make catch-up contributions of $500 a year, an amount that rises to $1,000 in 2006.)

What's more, you can contribute the max only if you meet the Roth's income eligibility rules. If your income is too high, you may not be able to make the maximum contribution.

If the amount you'd like to save exceeds the amount you can stash away in a Roth, you may want to throw some money into your 401(k) even without a match.

One final thing to consider is convenience. The beauty of a 401(k) is that the money goes into your account before you get your greedy little lunch hooks on it. It requires a lot more discipline to invest the funds on your own.

So while many people may plan to fund a Roth, some of them never quite get around to it. If you think that might be a problem for you, then you might want to stick with your 401(k).

After all, even if it turns out a 401(k) isn't as good a deal for you as a Roth IRA, it's certainly a better deal than not putting the money away at all.

Walter Updegrave is a senior editor at MONEY Magazine and is the author of "Investing for the Financially Challenged." He can be seen regularly Monday mornings at 7:40 am on CNNfn.  Top of page

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