Which is Better: 401(k) or Roth IRA?
I am 20 years old. I make $20,500 per year, of which I contribute 10% to my company's 401(k) plan. There is no company match. Should I contribute to a Roth IRA instead? Also, my fianceacute;, who's 21, makes about $50,000 and contributes 10% to a 401(k). His company matches 4%. Should he lower his contribution to 4% of his salary and put the other 6% into a Roth IRA?
Wow. You and your fianceacute; deserve a "super saver" award. Not only are you the youngest couple I know who contribute regularly to a retirement plan, but you're also savvy about which plans are best in your situation.
Your instincts are correct for both yourself and your fianceacute;. Because your employer doesn't match your 401(k) contributions, you'd be better off putting your money into a Roth IRA. You won't get a tax deduction for your contribution -- as you would with a 401(k) -- but all of your withdrawals will be tax-free in retirement, when you'll almost certainly be in a higher tax bracket than you are now.
As a bonus, you can probably qualify for something called the Retirement Savings Contributions credit. You're eligible for the credit if you are single and earn $25,000 or less (higher limits apply for people who are married or are heads of household). To get the credit, you must be at least 18 years old, and you can't be a full-time student or be claimed as a dependent on anyone else's tax return.
Depending on your income, the credit is worth 10% to 50% of the amount you contribute to an IRA or to a 401(k) or other employer-based retirement plan, up to a maximum annual contribution of $2,000. So the maximum credit is $1,000, and it reduces your tax bill dollar for dollar.
For someone like you who is decades away from retiring, the simplest type of retirement investment is a target-retirement fund. Target funds start out with a high concentration in stocks and automatically become more conservative as you get older and closer to retirement.
All you do is select the fund whose name contains the year closest to your anticipated retirement date. T. Rowe Price, Fidelity and Vanguard all offer good selections of target-retirement funds.
As for your fianceacute;, he should contribute 4% of his salary -- in this case $2,000 -- to collect the full company match, and the next $3,000 to a Roth IRA. That lets him take advantage of tax breaks both now and in the future.