4o1k vs. Roth IRA vs. Backdoor Roth

Intro

Traditional 401k, Roth IRA, Backdoor Roth IRA are all options for people to save for retirement. It’s best to choose which ones suit you more so you get the best benefits when it’s time to take that money out.

What is Traditional 401k?

401k is an employer-sponsored retirement plan where you contribute pre-tax into the account so you won't pay any taxes on what you contributed.

You will have more money to invest instead of paying it to the IRS. You then take it out when you're 59.5 then pay the taxes you would have owed.

Pros of Traditional 401k

With traditional 401k, you contribute pre-tax money. This is great because you will be able to contribute more money than if you were putting in post-tax money. The maximum amount of money you can contribute is $19,000 dollars each year.

Cons of Traditional 401k

A problem with traditional 401k is that you have to start paying taxes once you start withdrawing the money at 59.5. It is unpredictable how taxes will be like when you’re 59.5 and you might end up in a high tax bracket.

Another con is that if you withdraw money before 59.5, then you have to pay a 10% penalty and pay income taxes. However, It is required to start withdrawing money at 70.5.

“Matching” With Traditional 401k

Your employer may offer something called a “match” where they contribute the same amount of money into your traditional 401k account.

For example, if you put 2% of your income into a traditional 401k, then your employer will also put that same amount into your traditional 401k. Now you have double the amount of money into your traditional 401k for that year.

What is a Roth IRA?

IRA stands for individual retirement account and it is a retirement account where you can contribute and invest up to 6 thousand dollars per year with post-tax money after the age of 59.5.

Pros of Roth IRA

Since you are contributing post tax money, you don’t have to worry about paying taxes at 59.5 when you start taking the money out.

This is great because it wouldn’t matter what tax bracket you fall into. Another great thing is that you can take out any money you contributed at any time as long as it isn’t any profit you made from it.

Problems with Roth IRA

Since Roth IRA has a lot of great benefits, there are some limits as to who can actually contribute anything to their Roth IRA account.

Some limits include:

• If you make more than 122k a year, you can’t contribute anything to the Roth IRA.

• If you’re married, you and the person you’re with can't have a combined income of more than 193k if you want to contribute to Roth IRA

Similar to the traditional 401k, if you take out your gains before age 59.5, you will pay a 10% penalty and you have to pay taxes. For example, if I contributed 6k then it grew to 7k, I can’t take out the 1k I made, only the 6k I contributed.

What is a Backdoor Roth IRA?

The backdoor Roth IRA is a way for high income earners to take advantage of the Roth IRA.

They do it by contributing money to a traditional IRA then converting that account to a Roth IRA account.

It isn’t legal to contribute to a Roth IRA if you make more than 122k but there are no income limits to converting a traditional IRA account to a Roth IRA account.

Which One Is Better?

Traditional 401k:

Best when you're making a lot of money now and are expecting to retire in a low tax bracket. There are uncertain future tax rates so it’s a bit risky.

Roth IRA:

Better for younger people with a low tax bracket. Good for people who will be making a lot of money in the future. It is worse for people with a current high tax bracket.