In your article “Which Retirement Account Should I Fund?” you recommended funding the Roth IRA once a company’s 401(k) match has been maximized. Why not simply continue funding the Roth 401(k) up to the maximum $18,000?
Both the Roth 401(k) and the Roth IRA are great vehicles for your assets to grow tax-free.
But as we mentioned in the article, Roth 401(k)s and Roth IRAs are governed by separate legislation. Funding your Roth IRA has some unique advantages over funding your Roth 401(k). The Roth IRA advantages aren’t enough to overcome an employer match but they are attractive enough to make us suggest funding your Roth IRA before maximizing your contributions to your Roth 401(k).
Here are two important reasons we suggest funding your Roth IRA over additional contributions to your Roth 401(k) which do not receive a match:
1. Contributions to a Roth IRA can be withdrawn so long as the account has been open for at least five years. This makes a Roth IRA a great place to store money and receive tax-free growth while still being able to spend it. Roth 401(k) contributions are much more difficult to withdraw if you need them.
Especially for young people who are a long way from retirement and may need to use some of their savings to purchase a house or start a business, the value of being able to withdraw money is significant.
2. A Roth IRA can be invested in anything. Roth 401(k) choices are limited by the retirement plan and often have higher expenses.
Depending on the plan, these could be significant drawbacks to funding your Roth 401(k). We analyze 401(k) fund choices regularly. For many, the selection of funds is difficult because they have several funds which mimic the S&P 500 and very few funds with which you can craft a diversified asset allocation.
Most 401(k) plans have higher fees and expenses than a Roth account would have. Company 401(k) plans do not have to have these drawbacks, but many do. We created our own “Dream 401(k)” and started offering 401(k) plans to our small business owners because we could not find someone offering the plan we wanted: one with low-cost diversified funds.
Many small business owners are seduced by the idea that extra fees for high-cost funds pay some of the costs of running that fund via what is called “revenue sharing.” The problem is that the person with the most money in the fund is often the small business owner himself. The small business owner always pays the costs of running the plan, revenue sharing just doubles them.
Even if you had a “Dream 401(k)”, the benefits of being able to withdraw your contributions would still make funding a Roth IRA more attractive than funding your Roth 401(k) after you’ve received the full employer match.
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