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Experts: Roth IRA Trumps 401k

September 28, 2005
Consumers saving for retirement are usually told to "max out" their 401k plans to amass the most money. But at least one group of personal finance experts says aging baby boomers would be better off putting that money into a Roth Individual Retirement Account.

Research done by Consumer Reports Money Adviser, the personal finance newsletter published by the editors of Consumer Reports and Boston University economist Lawrence Kotlikoff, shows consumers sticking religiously to their 401k could actually be decreasing their spending power upon retirement.

Typically, Roth IRA accounts provide no up-front deduction but impose no tax on withdrawals. Another choice, saving on your own -- accumulating regular assets without a tax-deferred envelope like a 401k -- is a much better tax deal than it was in the past, particularly if you invest your savings in stocks.

The reason: Capital gains and dividends on stocks are now taxed at a maximum rate of 15 percent. If a consumer retiring today has the exact same stocks within her 401k she would pay ordinary income taxes at a higher 25 percent income-tax rate when she withdraws the money, if her income is between $29,700 and $71,950.

With the help of Boston University economist Lawrence Kotlikoff, CRMA guides consumers through the decision process by providing answers to questions such as:

• Does the Roth IRA always beat out the 401k?

• How does the Roth IRA compare with the 401k?

• How will future tax hikes affect the withdrawals from a 401k? The Roth IRA? Personal investments?

• How might contributing to a 401k affect future Social Security income? How is this different for a Roth IRA or personal investments?

• How to choose the best plan.

While most Americans who adhered to the 401k mantra are happy they did so, it turns out that having a decent amount of spending power in retirement depends mostly on willingness to save early and often. Ultimately, the editors of CRMA recommend a two-pronged strategy: Invest the maximum in a Roth IRA. Then plow at least enough into your 401k to get the full employer match. That is, save and save again.

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