Do you focus on your 401(k) or go after the popular Roth IRA? Heres a quick way to simplify your decision:
The withdrawals youll one day make from your 401(k) are not tax-free, but because your contributions are withheld on a pre-tax basis, youll pay less federal income taxes throughout the years that you contribute.
Distributions from a Roth IRA on the other hand, are generally considered to be tax-free, since youve already paid taxes on the money before depositing it into your IRA.
As to which investing option is best, you should ideally have both because each offers you a unique way of minimizing your taxable income while stashing away some cash for your retirement. But instead of trying to spread your savings out evenly between the two, focus first on your 401(k).
Most companies match up to a certain percentage so if youre not contributing the maximum matching amount, youre giving up free money. Granted, youll have to stay with your employer for the required number of years to be vested in that free cash, but many employers offer a scaled vesting plan so each year brings you a little closer to another chunk of extra green.
Then, once youve maxed out your 401(k) and taken advantage of employer-matching, turn your attention to a Roth IRA. Unlike your 401(k), theres usually no penalties for early withdrawals from a Roth, making your savings much more liquid should you need them before retirement.
Paul Kraft is co-founder and administrative principal of Frank & Kraft, one of the leading law firms in Indiana in the area of estate planning as well as business, tax and financial planning. For more information on planning your retirement, visit our website.