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401k Vs Roth IRA: Definitions, Rules And Contributions
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Published: December 28, 2006
The past year has witnessed much debate about the future of Social Security.
The need for retirement savings is more relevant than ever due to the steadily increasing senior citizen population. Uncertainty and confusion abound due to the number of options currently available. Two of the most heavily discussed options are 401k and Roth IRA.
401k
The definition of a 401k is a retirement savings account in which both the employee and employer contribute funds, which are exempt from taxes until withdrawn.
A 401k plan basically allows employees to save money on a pretax basis through their employer. The employee gets to decide the contribution amount, which cannot exceed the maximum amount of $15,000 allowed by the government for the year 2006.
The employee also gets to determine where to invest his or her contributions based on a list provided by the employer. The list usually includes stocks, bonds or money markets.
In a 401k plan, most employers will match their employees' contributions. Contributions are deducted from the employee's paycheck before taxes are withheld.
401k Rules
Funds must begin to be withdrawn at the age of 70 ½. Failure to do so or withdrawing less than the minimum amount required will result in a tax penalty. However, individuals with a 401k plan may begin withdrawing their money as early as the age of 59 ½ without fear of having to pay a penalty.
Roth IRA
The definition of a Roth IRA is an individual retirement savings account in which an individual can contribute funds where the tax has already been paid, making it tax exempt upon withdrawal.
A person can contribute to his or her Roth IRA account even after they reach the age of 70 ½. Upon death of the owner of the Roth IRA account, funds can be withdrawn tax-free by heirs.
Roth IRA Rules
For 2006, an individual with a Roth IRA cannot make contributions exceeding $4,000 per year. An individual also must earn an income at least equal to his or her contribution amount.
Simple IRA funds can be withdrawn without penalty beginning at the age of 59 ½. However, the funds must be in the account for a minimum duration of five years before they can be withdrawn. Fund drawn prematurely are subject to tax and a 10 percent penalty.
So, which plan is the best option? It all really comes down to personal preference. With a 401k, taxes do not have to be paid until the money is withdrawn. This is slightly advantageous if tax rates remain the same. However, a Roth IRA is better if a person wants to leave funds to heirs or wants to let their money compound past the age of 70.
Sources:
Krants, Matt. Roth IRA vs. 401 (k):A Guide for the Perplexed. USA Today. 25 Nov. 2005. 21 Dec. 2006 < http://www.usatoday.com/money/perfi/columnist/kran tz/2005-11-25-retirement-accounts_x.htm>.
McKinney, Jennifer and Mckinney, Patrick. Traditional vs. Roth IRA. About: Retirement Planning. 2006. 21 Dec. 2006 .
Updegrave, Walter. Roth vs. 401(k). CNNMoney.com. 11 March 2003. 21 Dec. 2006 .
The need for retirement savings is more relevant than ever due to the steadily increasing senior citizen population. Uncertainty and confusion abound due to the number of options currently available. Two of the most heavily discussed options are 401k and Roth IRA.
401k
The definition of a 401k is a retirement savings account in which both the employee and employer contribute funds, which are exempt from taxes until withdrawn.
A 401k plan basically allows employees to save money on a pretax basis through their employer. The employee gets to decide the contribution amount, which cannot exceed the maximum amount of $15,000 allowed by the government for the year 2006.
The employee also gets to determine where to invest his or her contributions based on a list provided by the employer. The list usually includes stocks, bonds or money markets.
In a 401k plan, most employers will match their employees' contributions. Contributions are deducted from the employee's paycheck before taxes are withheld.
401k Rules
Funds must begin to be withdrawn at the age of 70 ½. Failure to do so or withdrawing less than the minimum amount required will result in a tax penalty. However, individuals with a 401k plan may begin withdrawing their money as early as the age of 59 ½ without fear of having to pay a penalty.
Roth IRA
The definition of a Roth IRA is an individual retirement savings account in which an individual can contribute funds where the tax has already been paid, making it tax exempt upon withdrawal.
A person can contribute to his or her Roth IRA account even after they reach the age of 70 ½. Upon death of the owner of the Roth IRA account, funds can be withdrawn tax-free by heirs.
Roth IRA Rules
For 2006, an individual with a Roth IRA cannot make contributions exceeding $4,000 per year. An individual also must earn an income at least equal to his or her contribution amount.
Simple IRA funds can be withdrawn without penalty beginning at the age of 59 ½. However, the funds must be in the account for a minimum duration of five years before they can be withdrawn. Fund drawn prematurely are subject to tax and a 10 percent penalty.
So, which plan is the best option? It all really comes down to personal preference. With a 401k, taxes do not have to be paid until the money is withdrawn. This is slightly advantageous if tax rates remain the same. However, a Roth IRA is better if a person wants to leave funds to heirs or wants to let their money compound past the age of 70.
Sources:
Krants, Matt. Roth IRA vs. 401 (k):A Guide for the Perplexed. USA Today. 25 Nov. 2005. 21 Dec. 2006 < http://www.usatoday.com/money/perfi/columnist/kran tz/2005-11-25-retirement-accounts_x.htm>.
McKinney, Jennifer and Mckinney, Patrick. Traditional vs. Roth IRA. About: Retirement Planning. 2006. 21 Dec. 2006 .
Updegrave, Walter. Roth vs. 401(k). CNNMoney.com. 11 March 2003. 21 Dec. 2006 .
