401Ks and IRAs, should I have both?

[Guest Tyler015]

OK, heres my situation. I'm a recent college grad with a decent job and I want to start saving for retirement. I make around $40,000 a year with salary and bonuses and my employer's 401k plan will match up to 6% of my contribution. I have heard that ideally, I should be depositing around 10% of my income for retirement, so here is my question: Would it be smarter to put all 10% in the 401k and only get a match on some of it or would it be better if I put the extra 4% into an IRA account? If an IRA is better, could anyone suggest which one would make the most sense in my situation? Thanks in advance for all the help.

[WDIK]

You are already doing the two smartest things, namely saving 10% of your salary for retirement and taking full advantage of the plan's matching contribution. Opinions as to whether one option is better than another for the additional 4% savings are as varied as an individual's circumstances, so it is difficult to say what is best for you. It would depend on a variety of factors (such as fees, investment options, etc.) that are specific to your situation.

[Guest jbo]

I'm in the same boat as you are and I keep reading people suggest to do both. They say always do the 401k plan up to at least matching and then the rest in a Roth IRA. I'll tell you what made me want to open a Roth IRA account. For one you put the money in after your taxes, there's no telling if the taxes are going to be higher in the future, but you know what you have in there the earnings you can pull out when you are 591/2 without paying taxes. Second is that it's not a smart idea, but you can pull out the contributions you put in without being penalized. My 401k plan for instance if you take out money, you get taxed on it.......... guess what you have to pay it back and then when you retire you will take it out and pax taxes on it again. You'll pay taxes on it twice if you need the money. So for emergencies the Roth IRA is really the wya to go and actually you can take out the earnings you made if you are unemployeed for a long time and so many other reason.

I know that for instance my 401k plan I went to a seminar and they told use that we have to tell them how much after retirement we want. For instance we tell them we want them to send use a check of 1k every month. YOu cannot go and change it back to another figure or say your roof is leaping and you need to come up with 5k. You cannot get that money out of your 401k plan (well maybe at least not mine), but with a Roth IRA you can pull out what ever money you want when you want it after 59.5 without being penalized.

There's so many reasons it seems to have a Roth IRA than not to have one. For me it seems like you have the best of both worlds. You have a retirement account that you will get money before taxes and another account that you get after taxes.

Right now I'm doing 8% on my 401k plan and I'm planning on changing it to 5% and 5% with the Roth IRA.

The only negative thing I heard about the Roth IRA is that if you make over some figure around 100k you cannot contribute. The nice thing is that if you start you just cannot contribute anymore, but what you put in can still earn money for you. They are trying to change this limitation.

Also in 2006 if I'm not mistaken they were talking about allowing 401k to have a Roth IRA as part of it. It was proposed is all that I heard and people were talking about it, but I'm not sure if it's going to happen and even if your employeer will have it, but if you even do a search in goolge you'll find a lot of information on it.

For me it's not a question about if I shoudl have a Roth IRA account, it's more like what to invest in. Hope I was some help, since i"m a recent college grad also in a similar boat as you

[Guest fatabbot]

jbo,

I'm not quite sure that you have your facts straight.

If you take money out of your 401(k) and then get taxed on it, that's a distribution which doesn't have to be paid back to the plan. A loan on the other hand is not taxed when you take out money, but it is instead paid back using after tax money. So paying back a pre-tax contribution with an after-tax payment isn't ideal, but you don't get double taxed on it as you were implying.

[Guest jbo]

Maybe you misunderstood me. When I was referring to taking money out I was talking about taking it out before retiring. Taking out a loan..........

I know a few people are took out money from their 401k plan for their house and they were taxed taking it out and as they put it back in they will be taxed when it gets pulled out.

I just re-read what I posted and maybe I wasn't clear. I went from the Roth IRA talking about not being penalized for taking out contributions (so I'm talking pre-retirement = before 59.5) and then I jumped into the 401k plan so I was comparing taking money out say when you are 30 years old from the 401(k) plan versus the Roth IRA.

Actually as I was searching for some information I found it here

http://www.suzeorman.com/igsbase/igstempla...ID=20&SnavID=69

You originally invested in the 401(k) with pre-tax money. But if you take out a loan and then repay yourself, you will put money back into your account that is after-tax money. That is, money Uncle Sam has already taken his chunk out of. Now let's jump ahead a few decades and you are starting to make withdrawals from your account. Every penny you withdraw from a 401(k) is taxed at your ordinary income tax rate. So that money you put back into the account when you repaid your loan is going to get taxed...AGAIN. You are going to pay tax twice on that money. Please explain the logic in that.

[WDIK]

Please explain the logic in that.

http://benefitslink.com/boards/index.php?s...opic=16641&st=0

[Guest fatabbot]

Maybe you misunderstood me. When I was referring to taking money out I was talking about taking it out before retiring.  Taking out a loan..........

I know a few people are took out money from their 401k plan for their house and they were taxed taking it out and as they put it back in they will be taxed when it gets pulled out. 

I just re-read what I posted and maybe I wasn't clear.  I went from the Roth IRA talking about not being penalized for taking out contributions (so I'm talking pre-retirement = before 59.5) and then I jumped into the 401k plan so I was comparing taking money out say when you are 30 years old from the 401(k) plan versus the Roth IRA.

Actually as I was searching for some information I found it here

http://www.suzeorman.com/igsbase/igstempla...ID=20&SnavID=69

You originally invested in the 401(k) with pre-tax money. But if you take out a loan and then repay yourself, you will put money back into your account that is after-tax money. That is, money Uncle Sam has already taken his chunk out of. Now let's jump ahead a few decades and you are starting to make withdrawals from your account. Every penny you withdraw from a 401(k) is taxed at your ordinary income tax rate. So that money you put back into the account when you repaid your loan is going to get taxed...AGAIN. You are going to pay tax twice on that money. Please explain the logic in that.

jbo,

How is that different than what I said? Money that's taxed is a distribution. Your friends obviously took out a distribution rather than a loan for the amount to put towards their house. Let's say that you take a $10,000 loan for a down payment on the house. That $10,000 isn't taxed. Yes, you repay it with after tax money, but that $10,000 you received from the plan is never taxed as long as you don't default on the loan. However, is the $10,000 is distributed as a hardship distribution, then yes the money's taxed but you don't have to pay it back.

[Guest jbo]

Ok maybe this is what I"m talking about. YOu take out a loan and you are saying you pay it back right? Well you are taking out a loan that's before taxes right? and you are putting money back in...that's after taxes...right?

Then you pull it out when you retire and you pay taxes again right?

I understand what you are saying, but I can just tell you from what I'm reading and from what my coworker is going throught right now. He wished to god that he would have gone with a Roth IRA himself instead of th 401k to take out the money.

He really does explain it well here

http://www.suzeorman.com/igsbase/igstempla...ID=20&SnavID=69

I know we are starting to get off subject though.

[Guest 401der]

The principal amount of the loan is taxed only once (despite what Suze's link indicates); it is only the interest that is taxed twice. Think of it this way. Suppose you took a $10,000 loan from the plan on 1/1/2005 and just put the money in a mattress. Then on 1/1/2006 you take the money from the mattress plus $500 from your checking account to cover the interest and you repay the loan in full. No double taxation upon subsequent distribution except on the $500 interest, right? Now, let's say you had $10,000 of after-tax money in another mattress and when you repaid the loan you accidentally used the after-tax money from the other mattress. All that has occurred is the the "pre-tax" and "after-tax" tags have been switched, and now the $10,000 you put back in the plan is "pre-tax" and the money still in the mattress is "after-tax." That's essentially what happens with plan loans. No double taxation.

[Guest jbo]

all these examples are startign to confuse me.

Isn't this the way it goes

You have 100k in your 401k plan and you take out 20k loan when you are 30. You are taxed when you pull the money out (*** taxed once)

Then you pay it back everything when you are 35 years old. Now you retire when you are 70 years old and you have only 500k in your 401(k) and what you take out you are taxed. You are taxed on the entire 500k, even though you were already taxed on the money you took out and put back in, you are taxed on the total.

Instead of more examples is this incorrect or correct?

Say you pay 25% taxes, I think what suze is trying to say is that when you retire it should be 25% taxes taken from 500 minus (20k that you borrowed were taxed on and put back.

So basically since you are paying tax on the entire 500k, in my eyes you are paying twice. I understand what you are talking about 401der.... the entire point was that you don't have this problem with the Roth IRA and how the thread started and it just is getting carried away.

[Guest 401der]

There's the flaw in your information. If you take out a loan, it is not taxed at that time. You repay the loan and then, years later, when you take a distribution, that is when the amount becomes taxable to you.

[mbozek]

The last place to get advice on whether to take out a plan loan are financial columnists who act like they are experts on all things which they are not.

While a plan loan should be used only when other sources of credit are unavailable (e.g., home equity loan) it is not a bad idea if :

You cut the rate of interest you are paying on a loan since most plan loans charge 7% for a max of 5 years compared to 18%+ for credit card loans.

The risk of losing your job is minimal or you can activate a line of credit if you have to pay off the plan loan. Paying off a plan loan even for a few years is better than paying exhorbant cc interest rates and if you have go to back to the cc card loan you will have a lower balance.

Paying back the loan with AT dollars is no different than paying off any other loan e.g., home mortgage. The principal will always be repaid with AT dollars if you have to use taxable income to pay it off (only exception is if you use municipal bond income to repay the loan). Since you did not pay tax on the principal you are not paying income tax on the repayment. The interest is AT under the tax law which is why it is preferable to borrow from a home equity account first but this is small distavantage since rates are low and most taxpayers are in the 15% bracket which results in only a 1% tax benefit (.15x 7) on tax deductible interest.

The loan interest is paid back to your account which guarantees a 7% return. Historically equity markets have averaged 8-10% over long terms of 10 years or more. 7% compares favorably with a fixed rate of return on bonds which every diversified portfolio should invest in. If you take out a loan from your 401k plan you should rebalance your investments to reduce fixed income and cash and reallocate a larger % to equities since the loan is performing the role of a bond fund.

Dont be deceived by the roth IRA because you paying your taxes up front on the contribution and losing the opportunity cost to invest on the amount of taxes paid, eg. $1000 in tax @8% for 20 years is $4661 in lost investment return.

[rlb64]

mbozek, just to clarify, let's assume the person pays 15% tax rate. If this person wants to invest pre-tax, then the person could invest $7,843.14. At 8% over 20 years, it grows to $36.556.53. If the person pays the same tax rate after 20 years (after withdrawing the entire account), the person is left with $31,073.05.

If roth, the person invests $6666.67 ($7843.14 less 15% tax), grows at 8% over 20 years to $31,073.05.

So, it seems the Roth is better if you expect your tax rate to be higher at retirement than it is now while pre-tax is better if you expect a lower tax rate. If pre-tax, the tax savings is at a rate equal to your top braket... while at retirement, the withdrawal is likely not entirely taxed at the same top tax braket rate even if your retirement replacement income remains relatively level.