As the Rolling Stones said, “Time is on my side.” And so it is with younger investors, time is clearly on their side. The benefit to a Roth IRA or Roth 401(k) plan is that if all of the requirements are met, the distributions are tax-free. To fund a Roth IRA you will need to have earned income. This is the wages you earn as an employee or any self-employed income from a business you may run. The maximum contribution to a Roth IRA in 2013 for someone under age 50 is $5,500. There is a so-called ‘catch-up’ provision of an additional $1,000 for taxpayers over age 50.
The maximum contribution to a 401(k) plan or Roth 401(k) plan in 2013 is $17,500. There is a so-called ‘catch-up’ provision of an additional $5,500 for taxpayers over age 50. Not all employers will offer a Roth 401(k). That’s fine. If your employer offers a 401(k) plan and there is an employer match, sign up for the plan and contribute at least the amount required to get the full employer match. The employer match is an employee benefit you need to be taking advantage of. If your employer offers a 401(k) plan but not a Roth 401(k) plan ask them if they could adopt this plan.
Most younger investors tend to be in the lower income tax brackets. As you grow older and hopefully, become upwardly mobile, your earnings and income tax bracket will increase. Perhaps when you are older, making more money and in a higher income tax bracket a 401(k) plan might make more sense.
A Roth IRA offers more flexibility that an IRA. With an IRA you are allowed an income tax deduction for your contribution. With an IRA any distributions are subject to income tax. Additionally most distributions made before age 59 1/2 are subject to a premature distribution penalty of 10%. This is not the case with a Roth IRA. With the Roth IRA if the account is open more than 5 years and distributions are made after age 59 1/2 then all of the distributions are tax-free. However, a Roth IRA owner can always take out their contributions at any time and they are not taxable. Roth contributions are deemed to come out first.
If you are a young investor are you funding your Roth IRA or Roth 401(k)?