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Should I Invest in My Roth IRA or 401k?

If you’re like the people I know, you probably don’t have the $40,000 that would be necessary to max out your 401k, your spouse’s 401k, and each of your Roth IRAs every year. As such, you’ve got to prioritize. Here are a few things to keep in mind when choosing between funding a Roth IRA or your 401k at work.

[Note: This article assumes that you don't have a Roth 401k option at work. If you do, the question mostly comes down to just 401k vs Roth 401k, which is really just a question of your tax bracket now as compared to later. This article also assumes that you're eligible to contribute to a Roth IRA.]

Does your employer offer a match on 401(k) contributions?

If so, you should at least make sure to contribute as much as is necessary to receive the maximum contribution from your employer.

This is one of the few times in the world of investing that conventional wisdom is spot on: Employer matches really are free money. Don’t throw them away!

What if your employer doesn’t offer a match?

Once you’ve maxed out your employer match–or if there’s no match to take advantage of–it becomes a more difficult question. I’d focus primarily on the following two factors:

  • Your current tax bracket as compared to your future tax bracket
  • Quality of investment options in your 401k

Tax considerations:

The precise calculation is a bit more complicated, but in general, if you expect to be in a higher tax bracket when you retire than you’re in at the moment, a Roth IRA will give you better tax consequences for your investments than a 401k.

Granted, this question is impossible to answer with perfect confidence, as we all know that tax rates are not permanent. Rather, they’re set by politicians, and every politician seems to have a different idea about precisely how each dollar of income should be taxed.

Quality of Investment Options in Your 401k

If you decide that it’s better from a tax perspective to invest via your 401k, it’s still a good idea to make sure there are some suitable investment options before just jumping in. (For guidance, take a look at my article from earlier this week about how to choose funds in your 401k.)

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