401K or Roth IRA, Which Is Best?

Reader Question:  I have both a 401k as well as a Roth IRA. I’m obviously putting enough in at least for the match. Which one should I put additional money in after the match? I’m 30 years old and not sure which one would give me the best tax treatment. E.L.

Answer:  First, I’m glad to hear you are capturing your company’s matching contribution.  Way too many people leave this “free” money on the table.  Once you’ve invested enough to get the matching contribution, choosing the best place to invest more money is both a great question and the right question to ask.  From a tax efficiency standpoint, if you’re in a relatively high income tax bracket, you should contribute where you’ll get a tax deduction…your 401k or possibly the tax deductible IRA if you qualify.  Otherwise your best bet is a Roth IRA.  For 2014, the maximum contribution to a Roth or traditional IRA is $5,500 ($6,500 for those of us over age 50!).  As you think about planning for your retirement, I do like developing “multiple buckets of wealth”.  For example, you might end up with money in your 401k, a Roth IRA, a personal investment account and real estate (home).  At retirement, with multiple buckets of wealth (and no paycheck), you are able to creatively control your income taxes by choosing which buckets you draw from…choosing between taxable sources versus non-taxable sources.  As an example, we have a case where, for specific reasons, we wanted to pay ‘zero’ income taxes for as long as possible and by using multiple buckets of wealth, we’ve essentially created $80,000 per year of retirement cash flow without paying income taxes for the past eight years.

Reader Question:  We are heavily in debt with HELOC and rental property mortgages. I have a 401k at work but no employer match.  I am 55 years old and my husband is 61. Do you think we should be paying off the debts or contributing the maximum to the 401k?  We have very little money saved and have had numerous financial setbacks. We are trying to find a buyer for the houses which are all rented.  V.M.

Answer:  Selling the rental houses and using the proceeds to pay off debt is a good strategy.  The remaining question of whether to pay down debt versus invest for retirement is a question many people face.  The best answer is “both”, but requires an explanation.  My goal for retirees is to be debt free and have a large enough pot of money so that systematic withdrawals, along with Social Security, will appropriately fund your retirement.  With today’s low interest rates, it makes more sense to pay down on your home equity line of credit (HELOC) rather than putting a lot of money in savings such as a money market account.  You can still use your HELOC as your back-up reserve account.  At the same time, you need to be investing some money in stock mutual funds to grow a retirement nest egg.  If your income tax bracket is relatively high, use your company 401k or a deductible IRA.  If your income tax bracket is low, use a Roth IRA.  I realize that it’s hard enough to ask you to do one thing, much less two things…both invest and reduce debt, but sacrifices now will reap benefits during retirement.  I also strongly recommend you seek the help of a certified financial planner (www.cfp.net) to help you figure out a more detailed retirement strategy.  It may include working longer or perhaps working part-time during retirement.