If you’re worried about saving for retirement, you may be asking which would be better a 401(k) or Roth IRA. If you don’t have an emergency fund, the answer is “none of the above”. It’s really important to have the equivalent of five to six months of earnings saved up before you begin saving for retirement. The reason for this is simple. If you don’t have an emergency fund and you’re suddenly faced with a big auto repair or medical bill, you would have to either dip into your retirement account or use credit, neither of which is a good alternative. The same is true if you have some credit card debts that you need to pay off.
Does your company offer a 401(k)?
If your company offers a 401(k) plan, this is a much better option than starting a Roth or traditional IRA. This is because with a 401(k) plan, your employer will probably match a percentage of your contribution. The contributions you make to the plan will be salary reduction contributions on a post-tax or pre-tax basis. The plan may even include a profit-sharing feature. Any money earned in the plan accrues on a tax-deferred basis. Your plan may even allow you to direct your own investments with a group of investment products from which to choose.
Your employer’s contribution
If your employer contributes to your 401(k) plan it will be at the rate of fifty cents for every dollar you contribute up to a certain percentage of your salary. This will be either 3% or 5%. As an example of what this means if you were to contribute $3,000 over the course of a year, your employer would kick in an additional $1,500.
If there is no 401(k) plan
Unfortunately, some companies do not offer 401(k) plans. If your company is one of them, the true question isn’t which is better a 401(k) plan or a Roth IRA. The real question is which is better a Roth IRA or a traditional IRA as these will be your choices.
The biggest difference between a traditional and a Roth IRA is that the contributions you make to a standard IRA are tax deductible, while those you would make to a Roth are not. In other words, you can deduct the money you put in a traditional IRA but will pay taxes on it when you withdraw the money. In comparison, with a Roth IRA you cannot deduct your contribution but you pay no taxes on the money when you withdraw it, assuming you’ve had your Roth IRA for five years or more.
With either a traditional or Roth IRA, the most you can put into the plan each year is governed by law. For example, this year the maximum amount you can donate to a traditional IRA is $5,500 ($6,500 if you’re 50 or older) and ditto a Roth IRA.
Choose a 401(k) if possible
If your company does offer a 401(k), it’s a much better option than either a traditional or Roth IRA. However, if it does not have a 401(k) plan you’ll have to check out the details of both a traditional and Roth IRA and then make a decision based on which one makes the most sense for you given your tax situation and retirement goals.