401K plans

M

MarkMyWords

2
Hi all,

I am going to open up my first 401K plan (woot!) and just want some feedback. My company offers traditional 401Ks, with tax deferral, and Roth 401Ks, which pay tax then go into the account.

Here are my thoughts: the principle gets taxed regardless, whether it is now (Roth) or in 40+ years (traditional), it WILL get taxed. So, since I'm not making much, being just about the graduate and all, I'm in a reletively low tax bracket, so it seems like paying the tax now is wise.

As for the money that will be generated from the various stocks, mutual funds, bonds, etc...if I were to do traditional, this all accumulates, then the gov't gets to tax the earnings on top of the principle. However, with Roth, the principle gets taxed right off the bat, but all the earnings are not taxed, since when I take out funds, I won't have to recognize it as income. That seems like a big advantage, unless I'm not thinking of it in the right way.

Any input?
 
Yes, you're thinking about it correctly. Roth 401k is a nice benefit because the taxes on your return will be very significant in 40 years when you withdraw your funds. Plus, withthe Roth,you don't get taxed on your return, just the principle. I would suggest the Roth, but make sure you're taking full advantage of your companies matching policies.

I personally invest just enough in my companies 401k to get all of my employers match. The rest of my investments go into a Roth IRA...
 
Cool, thanks for chiming in. I'm glad I was thinking on the right track. I was already sort of leaning on the Roth, it seems like a good choice. And yeah, I will definitely put in the full amount that gets matched.
 
I'm with Skian, but definitely at a minimum put in enough to get everything matched by your employer if possible. It's free money and if you start early, it'll pay off in spades.
 
If your income tax rate stays the same now and when you take the money out of the 401k (or IRA) account, then traditional versus Roth ends up with the same amount of money.

For example, suppose $1 now grows, with good investment choices and reasonable luck, into $10 when you retire. Supposed you income tax rate is 25% now and when you retire.

Traditional: $1 goes in before tax, grows to $10, pays $2.50 in tax, leaving you with $7.50.
Roth: $1 pays $0.25 in tax, putting in $0.75, grows to $7.50, and comes out tax-free at $7.50.

Of course, the big uncertainty when comparing the traditional versus Roth scenarios is that tax rates may change, both legislatively and due to your personal situation (even if tax rates are the same years from now, you may be in a different tax bracket due to higher or lower income).

Note that either type of tax protected account avoids paying taxes every year on the investment income and capital gains of the year. This means that the money that would have been used to pay taxes each year instead stays in your investments to gain more money (if you make decent investments and do not have a lot of bad luck).
 
also remember that you have time at the start of a new calendar year to put money in your IRA and claim it on the previous years taxes, which can help when you start doing your income taxes.

I dunno exactly how it works but I've had several financial people tell me its true. there are limits, but since I always get raped on income tax, its worth it.
 
malkore said:
also remember that you have time at the start of a new calendar year to put money in your IRA and claim it on the previous years taxes, which can help when you start doing your income taxes.
Click to expand...

That is only for a traditional IRA, and you are under the income limit for that year's traditional IRA contribution to be deductible. See IRS Publication 590 on .
 
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