401(k) IRA

If you are confused by terms like 401(k), Roth IRA, stuff like that, you are not alone. After some intense reading, I have somewhat a rough idea and I will try to make it as simple as possible for you. 😉


There are 4 types of retirement plans:

 

Traditional

Roth
401(k)

Traditional 401(k)

Roth 401(k)
IRA

Traditional IRA

Roth IRA

What’s the difference between 401(k) and IRA?
401(k) is a plan offered and managed by your employer, while IRA is a plan managed by yourself. The obvious advantage of 401(k) is that your employer often matches your contribution, in return you keep your retirement money at your employer. For IRA, you manage your own retirement money with bonds, stocks, etc. Of course you will need to know what you are doing.

What’s the difference between Traditional and Roth?
Traditional plans take your contribution from your pre-tax income, then tax you when you take the money out. While Roth plans tax your contribution first, then don’t tax you when you take the money out. So, based on the economic environment and your life circumstances, one may be better than the other.

Without going into some crazy math, here is a list of human-readable recommendations:

  1. Young & Low income (Roth)
    • Low tax bracket, pay the taxes now
  2. Young & High income (Traditional)
    • No tax deductible items: kids, houses, etc.
    • High tax bracket – defer the taxes
  3. Middle age & High income (Roth)
    • Have tax deductible items: kids, houses, etc.
    • Low tax bracket, pay the taxes now
  4. Middle/Old age & High income (Traditional)
    • No tax deductible items: kids, houses, etc.
    • High tax bracket – defer the taxes

If you are the kind of people that believe everything will balance each other out, that even though you don’t get taxed here but you will get taxed there anyways, then I would highly recommend you to just stay with the Traditional 401(k). That’s because your employer’s matching contribution and their professional pension fund management experience are pretty good base-line GAIN $$$ to your retirement money.

Hope this helps clear up some initial confusion. As always, for more info and all sorts of details check out wikipedia to get an idea, and consult professional financial advisors for recommendations.

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