If you don't have a 401(k) and make less than around $100,000 a year, yes, maxing out the Roth is the way to go. If you make more than that, you have to weigh the tax situation to decide which is best.

Here is what the familie would have if they put the money first into a Roth, then the 401(k) with 6% matching from the company.

Family A: $40,000 annually ($6000 toward retirement)

Puts all of the $6000 into 2 Roths. They don't have any left to put toward the 401(k), so they don't get a match.

Total in retirement at the end of the year: $6,000 (15%)

Taxable income: $40,000.

Family B: $80,000 annually ($12,000 toward retirement)

Maxes out 2 roths ($10,000), then puts $2000 into 401(k) over many pay periods, getting 100% match on their contribution (another $2000).

total in retirement at the end of the year: $14,000 (17.5%)

Taxable income: $78,000.

Family C: $120,000 annually ($18,000 toward retirement)

Maxes out 2 Roths ($10,000), then puts $8000 into 401(k) over many pay periods, getting 100% match on the first $7200 ($7200).

total in retirement at the end of the year: $25200 (21%)

Taxable income: $112,000.

By not funding the 401K until after they've contributed the max to the Roth, Family C ends up in the same place. Family B ends up with $2800 less in retirement. Family A ends up with $2400 less.


You can see what the advantages of matching are. The power of compound interest is the more you start with, the bigger pot you have at the end. That extra matching for Family A and Family B that they aren't taking advantage of could add up to hundreds of thousands of dollars in retirement, more than offsetting the retirement taxes that they will save by putting the money in the Roth.

I'm no expert by any means, but contributing up to the match, THEN to the Roth makes the most sense to me.

"From what I understand, ROTH IRAs only have a tax advantage if you think you will be in a higher tax bracket than you currently are when you retire."

From what I understand, unless your tax rate is ZERO when you retire, you're better off with a Roth IRA. All of the money that is earned in the Roth is not taxed. So, if you deposit $10,000 into the account and it magically grows to $100,000, you're only paying the average true-tax of 16% on the $10,000 ($1600). Your tax rate in retirement would have to be under 2% to beat that deal.

__________________
"Poor people work for their money. Rich people make their money work for them."

Cookie2,

You won't always be better off with a Roth. It really does depend on your personal tax situation and cost of living/inflation. Most people who can afford to max out the Roth at the $10,000 annually are in a higher tax bracket and are paying a lot more than $1600 in taxes on that. Some of them have to earn $14,000 (or more if their state income taxes are high) to be able to put the $10,000 in the Roth after federal taxes, medicare, social security, state income taxes, health care premium and insurance premiums are taken out.

Suppose that I have $1000 (pretax) that I can devote to retirement. I am currently in the 25% tax bracket. I have two choices. I can put the whole $1000, tax free, into my 401k, or I could pay the $250 in taxes today and put $750 in a Roth IRA. Let's keep SSI out of it for now. I'm not convinced it will be there in 30 years.

In 30 years, I retire. At 7% interest compounded annually, my original $1000 is worth $7612 in the 401k while the Roth originally at $750 is worth $5710. Magically, the Roth is worth exactly 25% less than the 401k, the amount that I spent on taxes originally.

Now, if I'm actually in the 30% tax bracket in 2038, after I pay out my taxes on the $7612 I am left with $5328. I would have been better off putting the money in the Roth. If I'm actually in the 16% tax bracket in 2038, I have $6394 after taxes and was better off with the tax-deferred 401k. If I'm in the same tax bracket, it's basically a wash.

One way or another, the government is going to get paid. You get to choose when you pay the taxes. If you think you would be in a lower tax bracket in retirement, deferring taxes makes sense. Most of us assume a higher tax bracket in retirement, which is why a Roth makes good sense for the majority of us (after funding the 401k to get the company match, of course). If it is going to be about the same, you have to decide if you would rather have more money now, or later, keeping in mind that a dollar now is worth more than a dollar will be 30 years from now.

The problem is having the money to put in, much less max out, a Roth or any other type of retirement plan. We don't live paycheck to paycheck but the extra we are able to put away has to be accessible in case of an emergency.

So for us, our retirement at the moment is our money market accounts. They earn more than savings or checking accounts and are readily accessible for those car repairs, new dishwasher, etc. that may and often do come up throughout the year. From my understanding, you can draw money out of your Roth tax free before retirement age but isn't there a five-year window before you can do that and not face penalties? If I'm wrong on that, then maybe I need to rethink a Roth.

You can withdraw your principal (the after-tax money that you put in) from the Roth without a problem before 59 1/2. But, any earnings on that principal are subject to income tax plus 10% penalty unless they are used for an exception, like a one-time down-payment on a house or medical bills. There is also something about conversions, I think. You should check the tax code to be sure.

freebiemom, I would urge you to see if you can come up with a little bit more money to be put towards a Roth, even if it is only $50 a month to start with. Then DONT TOUCH IT!! You are paying taxes on any earnings from those money market funds, which along with inflation is really going to eat into your returns. You may just barely be keeping up with inflation as it is now. For long-term like retirement, stocks or mutual funds really are the way to go, and if you keep tapping into your savings, you aren't going to get compound interest to work for you.

Boy, lately my posts have like the voice of doom in them!! I don't want to drag anyone down. I have just gotten really serious about our future and I think it is rubbing off on my posts!