A friend of mine got a new job. His new company has a 401(k) plan, but does not give a company match (even though they’re making money hand over fist, but that’s another thread). He’s 32, looking to buy a house (doesn’t have much in current savings), makes low 6 figures, and has a 30% bonus. Which would be the wiser investment?
I’m certain someone more knowledgeable than me will be along soon, but here’s my understanding. A Roth 401k is a new breed of 401k; i.e., it’s either offered through his company or it isn’t. I’m guessing you’re thinking of a Roth IRA. First of all, if he’s making in the low six figures, he may not qualify at all for a Roth IRA. Second, even if he does, the contribution is capped at (I think) $3000 or thereabouts. Third, whether he contributes to a Roth IRA or a traditional IRA, the money is post-tax. The 401k, on the other hand, involves pre-tax income and he can contribute up to $15,000 or so.
The rule of thumb (and, again, I may be completely wrong) is that you should max out your 401k and then contribute to an IRA. Neither one is inherently a better investment–it depends on what the money is invested in.
Traditional IRAs aren’t post-tax. They are made with pre-tax money and the earnings are tax-deffered, same as a 401 K.
The limit to a Roth IRA or traditional IRA is $4000/year. The rule of thumb that I heard was
- Contribute to 401K up to employer matching
- Max out IRA ($4000/yr)
- Max out 401k ($15,000/yr)
As for which is better, that’s hard to say. It is a question of whether you think your income (and thus tax bracket) will be higher now or later. IMHO Roths are better for someone relatively young, because as the Baby Boomers hit retirement taxes are going to have to go up to pay for Medicare and Social Security. I’d rather pay taxes on the money now while the rates are relatively low.
However, there is also no guarantee that they won’t re-write the tax laws and go after Roth IRAs too. And by choosing a Roth you are forfeiting all the compound interest on your taxes, which can be fairly substantial over the course of 40 years.
Just wanted to add here that Susan is correct, traditional IRA is pre-tax (though many people pay for it with post-tax funds and then deduct it on their tax return). Same with traditional 401k (with the exception that you never pay a 401k out of post-tax money).
Roth 401k and Roth IRAs differ in that you pay out post-tax money and all earnings on the investments are then freed from tax.
Since there isn’t muchincentive to inest inthe 401k plan because of matching, I’d suggest that your friend talk to a financial planner. Low six figure income is definitely a decent chunk of change, and it certainly makes sense to speak to someone knowledgeable. That 300 bucks (or whatever it is) you invest now might only make a difference of a few hunred dollars in earnings your first year, but compounded over time, that will be worth it.
Good luck to him!
He may be making too much money for a Roth. There are income limits–$110,000 for singles, $160,000 for married filed jointly.
However, if he starts a Roth and discovers after the fact that he is ineligible for that year, it isn’t a big deal to convert the thing over to a non-Roth. I mean, there is paperwork and special tax forms involved, but it’s not like the IRS dispatches thugs to your home to beat you for the error.
I knew I’d get something wrong! 
My friend abhors taxes (like me), and I think he’s in the highest tax bracket already. He makes less than $110k, but I was wondering how they count the bonus. I’ve talked to some other friends, and did some research on google, and it looks like for sake of flexibility and future tax implications, Roth is the way to go.
A question about the 401(k) though: tax is made on dispersal, not on the amount accumulated at age 59.5, right? If so, what is the minimum disbursement?
What is the diffrence between the two?
Everyone considers himself “in the highest tax bracket”, but that sentiment isn’t factually compatible with making less than $300,000/year, as I recall. I’m pretty sure the bonus counts as income just like any other, but I’m not an accountant.
I think Roth is up to $4000 a year now. I usually max it out.
(Yeah, I’m too lazy to condense. What of it?) 
Roth IRA first - The money spent on it is already taxed. Everything earned after that is tax free and the earlier that is started the better.
Since the company doesn’t match any of the 401K I would suggest a meeting with a financial consultant before investing in one. Without matching funds it has no real advantage and most corporate 401K’s are limited anyway. You are better off starting your own IRA because you have more options (more choices of investments). The big advantage to a corporate 401K (vs a personal IRA) is matching funds. Even if you don’t make a dime on the investments a matching fund of 25% is a hell of a return. Of course, you only make that return once, it doesn’t compound by itself, but the idea is to pick a fund that will grow steadily over time.
100K earnings would suggest a financial consultant.