401k vs Roth IRA
There is no age consideration when you are planning to take a retirement plan. Planning should be done at the early stages of the carrier but if you have overlooked it then it can be done at any stage of your carrier. A person who is planning for the retirement should be well aware of all the plans available to him. Among the best plans in the U.S. 401 K and Roth IRA top the list. These plans are very retirement friendly as they provide good tax benefit. Both the plans are designed to give maximum benefit on retirement, but are slightly different from each other.
401k
401k is a defined contribution plan initiated by the employer, where the employees can elect to contribute a portion of their salary towards the 401k plan. What employer does is he holds back some part of the salary of the employee and uses it as a contribution towards a fund which the employee gets after retirement. In some instances, the employer matches the contributions by the employee with some money on his own every year.
The deduction made from the salary towards this fund is not taxed till the withdrawal during the retirement (tax deferred), which is a benefit for anyone who opts for this plan. The interest earned on the amount is also tax free. Upon retirement you can elect to receive the distribution as a lump sum or distributed as monthly payments upon retirement.
Since 401k plans are very effective retirement plans that are capable of providing you the best shield in terms of financial security after retirement, the government and the employer would not encourage you to go for an interim withdrawal. That is why heavy tax penalties are inflicted on the person that wishes to go for early withdrawal in the 401k plan. You are eligible for withdrawal only if you are at least 59 ½ years old and if the fund is at least 5 years old. It means that the plan is not liquid and the employer cannot have money as he wishes. There is a 10% penalty imposed by the IRS if you withdraw the money before the age of 59 1/2.
You can still avoid the situation of paying harsh tax penalties in the event of early withdrawals from your 401k account provided you stick to certain strict withdrawal rules as far as a 401k account is concerned. Some of the cases where this penalty is exempted are qualifying disability, distribution to the beneficiary on or after the death of the participant, medical care (only up to an certain allowable amount), or on certain disasters for which IRS relief has been granted.
Some 401k plans allow borrowing of loan against the vested account balance. The loan is not taxable if it meets certain criteria. You can borrow a loan up to 50% of the vested account balance. The maximum amount of loan should not exceed $50,000. The loan has to be of course repaid within a period of 5 years, unless the loan is used to buy your main home.
It is also possible to transfer your old 401k plan if you switch jobs, and if your new employer has 401k plan. There are several types of 401k plans and one can choose according to his needs.
There are several types of 401k plans available to employers – traditional 401k, safe harbor 401k and SIMPLE 401k.
What is attractive in 401 k is the tax deferment option and the elective deferrals are always 100% vested. Assuming a person needs fewer amounts for a comfortable living than his younger days, paying taxes after retirement from the fund is not so painful.
Roth IRA
It is a retirement plan that resembles a permanent savings account. It has become very popular because it makes available tax free earnings for an employee. There are two conditions that need to be met. The employee’s age must be at least 59 ½ and his fund must be at least 5 years old before he can withdraw money from it. Most of the benefits are similar to 401k, except for the difference in tax benefits. In Roth IRA An employee pays taxes now and faces no tax cuts later. Even the interest earned on fund is tax free, which is why more people are opting for Roth IRA. Normally, a person can contribute up to $4000 per annum into his fund, but if he is above 50, this contribution can go up to $5000.
In Roth IRA all qualified distributions are penalty free and tax free, but like any other retirement plans, non-qualified distributions from a Roth IRA may be subject to a penalty upon withdrawal. Also contributions can be made to your Roth IRA after you reach age 70½ and you can leave amounts in your Roth IRA as long as you live.
More information on Roth IRA
Difference between 401k and Roth IRA
The differences between 401k and Roth IRA are subtle, and often people have trouble deciding between the two. The major difference between the two lies in the manner the earnings are taxed. This is not significant if you have got a 401k plan where the employer makes a matching contribution. In Roth IRA, it is your money alone that goes into the fund, and is attractive as you get tax free earnings after retirement. Basically it boils down to whether a person wants to pay taxes now, or when he retires.
The other major difference between 401k and Roth IRA is the way they are managed. When you opt for 401k, you have no say in how the funds are controlled, and it is the sole prerogative of the employer to invest the funds. In Roth IRA, you are in better control of the funds.