February 16, 2011
By Staff Reporter
By Patrick Duffy
I am hearing a lot about Roth IRAs and 401(k). I am just totally confused with it all. Should I contribute to my 401(k) or start a Roth IRA?
– P.R., Queens
The very simple answer is: if you qualify and can afford it, do both. If you cannot afford both, give priority to the 401(k). If you feel that is beyond you, then start a Roth IRA.
Despite all the hullabaloo and publicity given to the new Roth IRA, a 401(k) plan is nearly always a better way to start building a retirement nest egg.
There are two aspects to a 401(k) plan that a Roth IRA simply cannot compete with. You can only contribute $2,000 to a Roth IRA on the assumption that you earn at least that amount in the year. The maximum contribution you can make to a 401 (k) plan is significantly larger, $10,000.
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Secondly, your employer may make a matching contribution to your 401(k). This match is tax free. There is no matching contribution in the case of the Roth IRA.
This company match is like the fuel of the booster rocket that will take you to your dream, financial independence during retirement. For instance, suppose your company match is 25 cents for every dollar you contribute and suppose your return on the investment is 10 percent, then the combination of these two is equivalent to a total return of 12.5 percent, and this growth is tax deferred.
The best thinking to adopt is to see if you can have the whole enchilada. In other words, do both. Avoid an either-or situation. Provided you are under the income ceiling for contributing to a Roth IRA, you can contribute to both. Contributing to one does not limit what you can contribute to the other.
Now suppose you estimate that your, or your and your spouses’, 401(k) contributions will be more than enough to fund your retirement, a little creative financial planning might be called on to use the Roth IRA to fund a major portion of your kids’ education costs.
Given the rules of the game, this is perfectly legal. However, from a psychological point of view, if you adopt this route of funding college education, make sure that just because the name is Roth IRA, you do not unconsciously count it toward your retirement.
Patrick J. Duffy MS, CFP is a certified financial planner practicing in New York City. He specializes in business and personal financial planning with the overall aim of enhancing an individual’s or family’s quality of life. His office is at 767 Lexington Ave., NY, NY 10021 and he can be reached by telephone at (212) 755-7736.
If you have a question related to business or personal finance, mail or fax it to the Business Section Irish Echo, 309 Fifth Ave., New York, NY 10016; (212) 686-1756. The Echo cannot guarantee it will publish every question it receives.