Here’s why I’d choose a Roth IRA instead of a 401(k) now | Smart Change: Personal Finance
(Sam Swenson, CFA, CPA)
You can achieve financial independence with a Roth IRA or a traditional 401(k). Many even choose to take advantage of both the vehicles and their respective tax benefits. But if I had to pick one to prioritize, a Roth IRA makes a lot of sense — even for high-income earners.
Here’s how a Roth IRA can unlock a tax-free and hassle-free retirement.
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Tax rates are set to rise in 2026
Since the Tax Cuts and Jobs Act of 2017, personal tax rates for individuals have remained relatively low on a historical basis. Provisions of the law relating to income tax are set to “expire” or expire at the end of 2025, which means that tax rates are set to rise across income levels in 2026. For financial planning purposes, it is important to know: Declare income voluntarily now It makes sense for it to be announced later, all else being equal.
Instead of taking a tax deduction to fund your 401(k) today, declaring income in the current year makes it available for filing into a Roth IRA. If you anticipate higher taxes in the future, you can take advantage of today’s lower tax rates and enjoy tax-free Roth IRA status for the rest of your life (assuming you keep the account open for at least five years). It’s also possible that tax rates will rise more than expected in the future, which will further amplify the benefits of today’s Roth IRA.
401(k) carry implicit tax obligations
When you look at the balance of a Roth IRA, you know that the money is entirely yours – forever. This is an unusual (and significant) feature, as you’ll need to be an active tax manager if you have a regular 401(k) or brokerage account. Distributions from traditional 401(k) accounts are taxed at the highest rate of income tax, while taxable brokerage accounts generate different types of income depending on the investments you own (I’m referring to capital gains, interest, and dividends here).
If you’re working with a pre-tax 401(k) in retirement, you’ll need to consider the impact on your tax return when you withdraw money from your account. Any withdrawals (sometimes in the form of required minimum distributions, or RMDs) are added to your gross income and taxed at your regular rate. In other words, a 401(k) pre-tax is Not It’s all yours, and it often turns out that anywhere from 10% to 50% of the account could end up as a tax expense. This depends on a variety of factors, but you need to keep in mind that your 401(k)s leave you with a deferred tax liability that must be carefully managed in retirement.
Good for investor psychology
A Roth IRA can provide a version of psychological freedom that most investment accounts do not. Knowing that the account is entirely yours – and will forever be – can help you feel more free and can help you simplify your financial planning. Never having to think about taxes again saves paperwork and accounting time, and helps maintain management ease.
Roth IRAs also come with achievable maximum contribution limits: In 2022, you can contribute $6,000 to a Roth IRA ($7,000 if you are over 50). Needless to say, maximizing your Roth IRA is a fairly manageable goal for most interested investors. If you are making a lot of money contributing directly to a Roth IRA, you can also consider making a Roth IRA contribution from the back door, which will eventually help you in the same place as if you were able to make a direct contribution.
Open a Roth IRA today
Although the best option is to keep both a 401(k) and a Roth IRA (and maximum contributions for as many years as possible), it is not always possible to find funds to contribute to both accounts. If you need to prioritize one account over another, it’s hard to argue the long-term benefits of a Roth IRA. Even better, Roth IRAs are free to open up to a wide range of investment options and offer a much wider scope than most 401(k) plans.
Zero tax liability for the rest of your life is not something you take for granted. Focus on making additional contributions and do your best to maximize your Roth IRA each year.
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