A recent contribution to the Investopedia “Advisor Insights” page can be found here.

Question Headline:
Should I invest my extra income in a 401(k), a Roth IRA, or spit the investments evenly into both?

Question Body:
I will be investing 15% of $27,000 a year into a retirement fund. This money is additional income from a new job. My new job offers a 401(k) with a match of 3%. I have also heard that a Roth IRA is a good choice. Should I do 15% in one or the other, or split it half and half? What do you think?

My Response:
You should take full advantage of your company 3% match, so you should be contributing at least 3% of your extra income into your 401(k). To decide where to invest the rest of your income, you need to understand the key differences between a traditional 401(k) and a Roth IRA.

401(k) contributions are tax-deductible reducing your current taxable income and therefore reducing how much you pay in taxes today. The funds within the account grow tax-deferred meaning there are no tax consequences as long as the funds remain in the account until retirement. In retirement (after age 59 ½) distributions from the 401(k) will be taxed as ordinary income.

Roth IRA contributions are “after-tax” meaning there is no reduction in the participant’s tax liability today. Funds within the account grow tax-free, and distributions made in retirement (after age 59 1/2) are tax-free.

In conclusion, you should contribute 3% into your 401(k) account. Where to contribute retirement savings beyond the 3% is going to be based on whether you prefer “to pay more in taxes today, but never again, or reduce your taxes today and pay in the future.” I typically recommend people with a long time horizon (20+ years) to take advantage of the Roth IRA option as much as possible as long as they are eligible. Investing in capital markets over the long-term can and should provide tremendous growth of assets. It is very powerful to never pay taxes on that growth.

— Wyatt Swartz

— Contributions by Eli Perlmutter

— 5/22/2017