401k or Roth - Which to max out first? Pros and Cons

Roth or 401k, Which to Max Out First?

Roth or 401k which should I max out first? asked Buck Inspire

This is an excellent question, which to max out first, a 401k or Roth IRA?

The easy answer, max out both the 401K and the Roth IRA! You can’t go wrong saving and investing as much as you possibly can now.

What if I Can’t Max out Both My Roth IRA and 401K?

In the real world we all need to make financial choices. Most investors can’t afford to max out their 401k and their IRA. So, how to allocate retirement funds is a common question.

If you can afford to max out both, here are the contribution limits for 2018:

401k Contribution Limits – 2018

The contribution limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan is increased from $18,000 to $18,500, according to the IRS. Those over age 50 can contribute an additional $6,000.

Roth IRA Contribution Limits -2018

Anyone can contribute $5,500 to a Roth IRA if they meet certain income guidelines. And if you’re over age 50, you can contribute $6,500.

Higher income earners may not be able to participate in a Roth IRA.

The income phase-out range for taxpayers making contributions to a Roth IRA is $120,000 to $135,000 for singles and heads of household. For married couples filing jointly, the income phase-out range is $189,000 to $199,000. The phase-out range for a married individual filing a separate return who makes contributions to a Roth IRA is not subject to an annual cost-of-living adjustment and remains $0 to $10,000 according to IRS.com.

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401k or Roth IRA - Which retirement account should I max out first?

Which to Max out First – 401k or Roth IRA?

First, if your company matches your 401k investment, make sure to contribute enough to get the employer match.

After you receive the free employer money, then the decision whether to go with the Roth or 401k depends on several factors.

The Pros and Cons of a 401k vs. a Roth IRA Retirement Account

An advantage of the 401k over a Roth IRA is that your contributions are tax deferred which means your taxable income is reduced by every dollar that’s paid into the 401k. So, if you make $70,000 and contribute $10,000 to your 401k then you’re only taxed on $60,000 income (for Federal taxes- state policies vary). 

Assuming solid, low fee investment choices and the ability to defer taxes, it makes sense to max out your 401k contribution.

There are several disadvantages to investing in a 401k. You might not like the investment choices offered by your employer. Another disadvantage of investing in a 401k over a Roth is that you must start withdrawing your 401k funds at age 70 1/2. And you have limited investment options in your 401k. There are a much wider range of investment choices in a self-directed Roth IRA.

And, don’t forget to get a free 401k retirement account check up with Blooom. It’s very quick and could save you fees and improve your returns.

Ultimately, if you don’t like the available choices in your 401k, then invest only up to the employer match and open up a Roth IRA for the rest of your retirement investing. 

If you like the choices and appreciate the opportunity to reduce your current tax bill, then invest as much as possible in the 401k. 

Bonus; Fidelity Retirement Savings Guidelines

The advantages of investing in a Roth IRA are that you never need to withdraw the money and the invested funds continue to grow and can even be passed on to your heirs. 

A disadvantage of investing in a Roth IRA is that your initial Roth IRA contributions aren’t tax deductible and are made with after tax dollars. Another disadvantage of Roth IRA investing is that high income investors aren’t able to participate. In that case, a Traditional IRA might be another option. Although, f you’re eligible, a Roth IRA is an outstanding wealth preservation and wealth transfer account. 

401k or Roth IRA – Predicting the Future

Another factor in your investment choice is your future tax bracket.

I don’t know about you, but I’m not a fortune teller. Although, I expect that tax rates will be higher in the future, since they at historically low levels now.

But, I’m not sure if my personal tax rate will be higher or lower at retirement. In retirement, my salary income will be eliminated and I’ll be living on pension income , Social Security, and our invested assets. So, I assume my retirement income will be lower than our family income is now. But, tax rates could rise. And I”ll be required to withdraw funds from my 401k account.

So, it’s likely that tax rates will be higher in the future, and income levels might be lower. 

If you really need a tax break now because your income and tax brackets are high, and you think that they will be lower in the future, then the 401k may be the one to max out first. That is, as long as you are happy with the investment choices available in the 401k.

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Finally, in the future, you’ll pay tax on the 401k withdrawals which must begin at age 70 1/2. And, you never need to withdraw your Roth IRA savings, if you don’t want to.

Bonus Roth IRA Investing Idea

One benefit of a Roth IRA, is that you might be able to encourage your kid to start a Roth IRA, with her summer earnings. A kid Roth IRA could actually make her a millionaire, by starting to invest early!

Ultimately, there’s no way to determine the perfect answer to this question now. The best answer is make sure to save and invest as much as you possibly can now. Look at the pros and cons of each option, then make your best decision. If you’d like some help managing your 401k investments, Blooom is a new tool to help you choose the best investments within you 401k. 


Updated; March 10, 2018. 

Disclosure: Please note that this article may contain affiliate links which means that – at zero cost to you – I might earn a commission if you sign up or buy through the affiliate link. That said, I never recommend anything I don’t believe is valuable.


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