Roth IRA vs. Employer Plan
Comparing the Roth IRA with your company's 401k or 403b plan.
Ideally you should be saving the maximum amount in both your employer plan and
an IRA. But many people find this simply isn't possible. There's only so much they can
manage to save for retirement in the course of a year, and they need to decide whether the
savings should go into a Roth IRA or an employer plan.
We're talking here about employer plans that provide a reduction in
your taxable income for the amounts you contribute. For example, if you earn $60,000 and
elect to have $5,000 of your earnings contributed to your employer's 401k plan you'll
report only $55,000 of earnings. The effect is similar to making a deductible
contribution to a regular IRA. You should be familiar with the ideas presented in
Roth IRA vs. Deductible IRA.
This page deals only with additional points you need to consider when your choice
involves an employer plan:
- Matching contributions
- Access to your savings
- Investment opportunities
- Creditor protection
Many employers provide matching contributions when you elect to have part of your
earnings contributed to a 401k or other employer plan. Employers have great flexibility in
this area. They can choose to match all employee contributions, or only contributions up
to a specified dollar amount, or none at all. And they can match on a dollar-for-dollar
basis or on some less generous basis, such as 50 cents (or less) for every dollar you
elect to contribute. It's important for you to know exactly how your employer's matching
contributions work. If you have any doubt, check with your employer or review the
Matching contributions greatly decrease the cost of saving for
You're in the 28% tax bracket and your employer matches 50 cents on the dollar for the
first $4,000 of contributions. At a cost of only $2,880 ($4,000 minus the 28% tax savings)
you can have an account balance of $6,000 ($4,000 plus the $2,000 employer match.
Of course you'll have to pay tax on the $6,000 (and any earnings) when you receive
benefits from the employer plan. But it's hard to beat the advantages of receiving an
employer match because of the leverage demonstrated in the example.
This is why most advisors feel that in a choice between a Roth IRA and
an employer plan with matching contributions, you should choose the employer plan, at
least up to the point where you no longer qualify for the match.
There may be some situations where you shouldn't necessarily follow
that advice. For example, you may have reason to believe your employment will terminate
before the employer match will become vested, so that you'll forfeit the matching
contribution. Or the match may be very small (say, 10 cents on the dollar) while other
aspects of the employer plan make it very unattractive. In general though, it's a good
rule of thumb to look to the employer plan first when matching contributions are
Access to Savings
Employer plans are both better and worse when it comes to getting access to your
retirement savings. On the one hand, you can borrow from many employer plans
something you can't do with an IRA. The ability to gain access to your retirement savings
by borrowing can be very valuable, because when the loan is repaid your savings are
restored, plus interest. If you had to withdraw the savings rather than borrow them, you
might find that there is no way to return that amount to a tax-advantaged form of
retirement savings when you're later able to do so.
On the other hand, employer plans generally restrict your ability to
withdraw funds while you're still employed including the money you
contributed. You can't simply demand to receive your account balance whenever you want or
need it (as you can if you have an IRA). In limited circumstances you may be able to
receive a hardship distribution, but you may find that you don't qualify and simply can't
get your hands on that money until your employment terminates.
Many people will think of this as a disadvantage of employer plans, but
you should consider it partly an advantage. The discipline this imposes to keep your
savings set aside for retirement may work to your benefit in the long run.
This is a point that is very important but often overlooked. Many employer plans
provide a very limited choice of investment opportunities. Sometimes the employer
determines the investments entirely; in other cases you may have a choice among several
mutual funds or other investments that don't perform particularly well. This is not to say that you can
necessarily do any better with your own choices. Yet there are simple methods of investing
(such as investing in a stock index fund) that typically do better than the majority of
mutual funds and may significantly outperform your employer's plan. Over the long haul a
seemingly small difference in investment performance can make a great difference in your
accumulation of savings for retirement.
Bear in mind that you can be much worse off if you put your savings in
an IRA and dabble with investments that end up producing losses. And some employer plans
offer excellent investment choices. It pays to be informed about your investment
alternatives before committing your money to one method of retirement savings or the
Federal laws concerning retirement savings provide sturdy protection for employer plans
from creditors of participants. You may lose some or all of your account in a divorce, but
it's generally protected from being seized by credit card companies or other claimants.
The amount of protection afforded to the owner of an IRA depends on
state law. Some states provide no creditor protection at all for IRAs; many others provide
only limited protection. If the possibility of bankruptcy is a concern, you should determine the
kind of protection your state provides to IRAs before choosing an IRA over an employer
plan for your retirement savings.