Question

Tim is having trouble deciding between a traditional and Roth 401(K). He is currently earning $500,000 per year as a CFO and expects to be earning only $50,000 per year upon retiring at age 70. Would you recommend that Tim contribute to a traditional or Roth 401(K) or another type of investment vehicle? Why? If Tim is ineligible for his employer's 401 (k) program, what other retirement savings options are available to him?

Answer 1

Roth 401(k) is similar to regular 401(k)s but differ in the way contributions and distributions are taxed. In Roth 401(k), contributions go in after-tax whereas retirement withdrawals are tax-free. If Tim prefers to pay taxes now or thinks that tax rates will be higher during retirement than the prevailing rates now, he should choose a Roth 401(k). If Tim maximizes the annual contribution to his retirement account, he will net more after-tax retirement dollars in a Roth IRA than in a traditional IRA mostly. In the long run, Roth will lead to higher after-tax IRA values and to adjust/match for the after-tax advantage of Roth IRA, a traditional IRA scheme will need to invest the tax savings from each year’s contribution.

In case Tim is ineligible for 401(K), he can try to set up an individual retirement accounts (IRAs) which is easy to manage providing valuable tax advantages. However, the key issue in saving in a traditional/Roth IRA is the low limit for contribution. So, Tim may also look for further alternatives and save/invest his money in a brokerage account, tax-deferred annuity plan or real estate investment trusts.