How To Compare 401K And Roth IRA?

The Roth IRA and 401k plans have long since been a popular choice for those that want to know how to plan for retirement? In January 2006 both of these retirement savings plans were combined to form a new retirement plan called Roth 401k plan.

Comparing Roth and the Traditional 401k is difficult as both of them share certain common features and their differences are very miniscule but do exist. When you compare 401k and Roth IRA it is imperative that the Roth IRA rules and 401k rules are observed.

The traditional 401 k plan was established in 1978 as an employer sponsored plan. In it, IRA contributions to the account are taxed according to prevalent income-tax rates. Similarly, contributions to the Roth IRA are also taxed according to prevalent income-tax rates. However, while in 401k the money accumulated has to be withdrawn by 70 years, there is no such age bar in the Roth IRA. This is a very important feature when you want to compare 401k and Roth IRA.

Also, distribution cannot be taxed if the account holder has crossed 50 years of age or the account is five years old. The ceiling on contribution to the accounts also differs. While 401k plan allows $15,000 as annual contribution, a Roth IRA account sets the limit at $4000 (2007 figures). The slab increases if the account opener is more than 50 years of age. Then he can contribute up to $20,000 in 401k plan and $5,000 in the scheme of Roth IRA.

A vital difference between them is the ceiling on the amount of contribution. The ceiling of 401k plan is much higher and there is no tax deduction at the time of contribution. Unlike Roth IRA it also does not have a low income bracket as a criterion for eligibility. The Roth IRA scheme sets it at $166,000 (according to 2007 figures) for married couples and $114,000 (according to 2007 figures) for single earning individuals. However, both these IRA plans assure shelter from taxation on contributed amount while the account is operational.

Both these plans have the option of withdrawing early and that too without any penalty if the following instances or hardships occur: education expenses of the self or the spouse, death or disability, and / or certain health problems.

The Roth IRA account also allows early withdrawal or no penalties if you are investing money for the first time in your house or you have maintained a Roth account for five years. However, such a provision is absent in 401k plan.

Account distributions in both the cases operate through the firms with which the account holders choose to start this retirement scheme. The interest is compounded without tax deductions and the final returns from investment would also be outside the tax net. 401k plan being a much earlier innovation and having a flexible entry criterion caters to a wide range of earners, while Roth IRA widens its scope by removing the age bar of contribution. Thus, both are efficient wealth building plans that guarantee economic security in post-retirement age. It is to your best financial interest to compare 401k and Roth IRA.