Should I contribute to a 401k or Roth IRA?

Employer retirement plans (401k’s, 403b’s, 457b’s) are a great way to invest; so are Roth IRA’s. It’s almost always advisable that you contribute an amount at least up to your company match.

So if your employer matches 50% of your total contributions, for up to 6% of your salary, it’s usually a good idea to at least contribute an amount to your 401k that equals that 6%-of-salary figure.

After that, tax planning comes in to play. 401k contributions reduce taxable income during the contribution year and are fully taxable upon withdrawal.

While Roth IRA’s provide their tax benefit at distribution, with those distributions being totally tax free (as long as you follow applicable rules).

The general rule of thumb says that if your future tax rate will be lower, it’s likely more efficient to use 401k’s versus Roth IRA’s (since you’d save taxes at your higher current rate, then withdraw later at your lower tax rate).

If your future tax rate will likely be the same or higher, it’s generally advisable to contribute to a Roth IRA so your withdrawals are tax-free later, rather than taking the tax benefit now.

NOTE: there are contribution/income limits that come into play as well.

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