There are pros/cons to both IRAs and 401ks. There are also differnces in 401ks, Roth 401ks, Traditional IRAs, and Roth IRAs, to name a few of the most common. 401ks are company sponsored and not all people's company offer 401k or 403bs for the private secretors like some healthcare.

Traditional 401k

PROS:

- Most employers will give you a match of what you contribute. For example, you may get a 100% up to 4% of your salary. So if you contribute $200 a month and it equals 4%, they will match that $200 every month.

- The contributions come out of your paycheck and are automatically deducted off of your taxable income.

- You can contribute up to $16,500 (for tax year 2009) if you are below 50, and up to $22,000 if you are 50 or older.

CONS:

- You are limited to the investment decisions you can make. Usually you will have a choice of five to twenty mutual funds and a stable value fund option.

- You don't have an advisor tagged to that account who you can go to for advice, because this is a work-sponsored plan.

- If you withdraw money from the plan, the plan may withhold 20% for taxes upfront (most plans do this) with additional fees a penalties. Also, the plan may not allow any partial withdrawals, it may make you withdraw everythin***

Traditional IRA

PROS:

- Depending on the institution you use, you will be able to have every investment choice open to you (stocks, bonds, mutual funds, annuities, CDs, REITs, etc.)

- You will be able to pick an advisor who can give you detailed advice on what to do.

- You can take partial withdrawals from the plan, and you don't have to have any tax withheld upfront.

CONS:

- There is no match on your contributions, because it is not an employer plan, so what you put in yourself is what you have.

- The contribution limit is currently $5,000 for people under 50, $6,000 for those above. Also, the contribution may or may not be tax deductible, it depends on your income and how you file.

- Phase outs on which you are not eligible for IRA
$105,000 - $120,000 Signal
$166,000 - $176,000 Married

Roth 401k

PROS:

- Roth 401(k) offers the ability for tax-free income at retirement.

- Roth 401(k) can be rolled into a Roth IRA. For those who make a lot of money, this could be an easy way to move money into a Roth IRA.

- As of right now, income received from a Roth IRA during retirement does not count when figuring the taxation of Social Security benefits.

- Unlike other accounts during retirement, there are no required minimum distributions with a Roth IRA.

- Tax rates could be higher in the future, which would make tax-free income in the future, more valuable.

CONS:

- A Roth 401(k) is funded with after-tax money, which means higher tax bills now and could possibly subject you to the dreaded Alternative Minimum Tax. I did a quick calculation and figured that our tax bill for 2006 would have been around $2,000 higher had we gone with the Roth 401(k).

- Along the lines with number 1, Roth 401(k) contributions will mean higher taxable income now. This could affect deductions.

- There’s really no guarantee that lawmakers won’t change their minds and begin taxing Roth IRAs at some point in the future.

- The employer match is put into a separate account, which will then be fully taxable at retirement. This is a wash since you don’t pay taxes or get a tax benefit from an employer match.

ROTH IRA

PROS:

- Tax-free withdrawals

- Money grows tax deferred

- Low/No management fees

- Invest in virtually any asset

- No mandatory withdrawals

CONS:

- Contributions made after taxes

- 10% penalty on early withdrawals

As with all investing, you should diversify the types of investments you make. You should also diversify the types of accounts you have for tax and other reasons.

Therefore, if you qualify, what I like to do is contribute the max of my company's match in my 401k. My company offers up to 6%, so I contribute 6%, that way I get all the free money I can get. Then I contribute to my Roth IRA and max it out. After that, I go back to my 401k and contribute any additional funds I can for the year. This allows for me to take advantage of the full match (free money) my company offers and diversifies the types of accounts, as well as allowing me to diversify the investments I can choose from.

Hope that helps.

Quote:

But am I missing something? Why doesn't everyone do this instead?

dowlow,

An IRA or a 401k or both "Qualified Retirement Plans."
There isn't really any difference between the two.

Are you going to drive your car to work today or would you prefer to take the automobile?
Same thing isn't it?

All that being said, if your employer was paying for the gas in your car for you to drive to work I doubt you'd take the automobile.

How does a 401k put you in a lower income bracket? At age 70 1/2 you have to take your Required Minimum Distribution (RMD) in all Qualified Plans EXCEPT a Roth IRA.

I believe in your post you are attemping to draw a comparision between a 401k and a Roth IRA but you only used the generic term IRA.

The 401k will win everytime with tax deferred growth and the added benefit of some level of employer contribution.

You'd be foolish to put dollars into a Roth IRA unless and until your 401k was maxed out.

My 2 cents.

__________________
Gary Spicuzza, *SAFE
Copyright 1956.
No Rights Reserved.
*Self Appointed Financial Expert

How would making withdrawals from a tax deferred account such as a 401k put you a LOWER tax bracket? You would be paying taxes on it therefore potentially bumping you up into a HIGHER tax bracket. Additionally, most people make more money as they get older, unless you strive to stay neutral in you job status and never want to make more money. So when they hit retirement they are generally in a high tax bracket then from when they were in their 20-30s, ect. Therefore paying 10-20% tax now in a Roth IRA is better then paying much high taxes on larger amounts of money later, when you really need it, such as a 401k. Also, 401k plans offer very limited fund options with generally outrageous fees compared to Trad. or Roth IRAs. You can choose anything you want in IRAs, 401ks you limited to normally about 10 expensive moderate to poor performing options. Fees will eat up much of your earnings if your not careful. Also, Roth IRAs can be used in case you retire early due to choice or other reason. Or, you can withdrawal funds any time after they have been in the account for 5 years. You can not withdrawal from a 401k early without a lot of penalties and taxes and can take out a loan against a 401k but you are required to pay it off in full if you leave or get fired from your job. All in all, it would be best to be diversified so you have options. Only if your company's 401k offers a match, contribute up to the company match, then max out a Roth IRA ($5,500 for this year), then if you have more to invest, return back to the 401k to make additional contributions. This way you get the company match, max out a Roth, have tax benefits of both, and additional leverage with the Roth in case something happens.

It's not necessarily the case that someone will have a higher income during their retirement. Yes they were probably further in their career path at that time but unless someone is extremely rich they tend to lower their expenses during retirement due to not being employed anymore. Also, the funds are generally withdrawn from retirement accounts over a longer period of time rather than in one big chunk right upon hitting at 59 1/2.

Our company uses a simple IRA. It works great for both the employer and employee. As an employee you may get dollar for dollar match up to the first 3% on your income. You also have some pretty sizeable contributions that you can make tax-free.

For the employer, it is very easy and inexpensive to administer. It is certainly an option one should look at.

I have a 401k (funded through my employer with contributions and a match) and a Roth IRA. The Roth is nice because the tax is already paid and assuming the govt doesnt decide to change any tax rules, I wont ever have to pay tax on the gains, which is a good thing given that I plan to be in a higher tax bracket by the time I retire. The 401k is a no brainer too though, esp if your employer offers a matching contribution of any kind.