Finance guru Dave Ramsey issues blunt retirement advice to Americans
Dave Ramsey has issued some blunt retirement advice to Americans about the benefits and pitfalls of 401(K) and IRA retirement plans.
The finance guru explained in a blog post how both plans are great ways to build wealth for retirement, but it is crucial to understand their differences and how they can work together before investing.
A 401(K) workplace plan is sponsored by an employer, he said, and often involves the company matching contributions taken out of workers' paychecks.
The money you put in is tax-deferred, which means you will not pay taxes on it until you start taking funds out in retirement.
A Roth Individual Retirement Account (IRA), on the other hand, is an account which you can open yourself to save a certain amount of after-tax dollars per year for retirement.
'When you hear the word Roth, your ears should automatically perk up - because a Roth IRA allows your savings to grow tax-free,' said The Ramsey Show host.
'That means once you turn 59 1/2, you can withdraw money from your account without owing a penny in taxes.'
Ramsey explained some of the advantages of a Roth IRA over a 401(K).
Dave Ramsey has issued some blunt retirement advice to Americans about the benefits and pitfalls of 401(K) and IRA retirement plans
Since you invest in a Roth IRA with money that has already been taxed, the money will grow tax-free inside the account, he said.
'And here's the deal: Once you're ready to retire, most of the money in your Roth IRA will be growth,' he explained.
'So, no taxes on that growth means hundreds of thousands of dollars stay in your pocket and out of Uncle Sam's!'
With a Roth IRA, you are not limited by 'some third-party administrator deciding which funds you can invest in', he continued, which means you have thousands of mutual funds to choose from.
Plus, it is not tied to your employer in any way, which means you will not have to roll over the funds if you switch jobs, which you have to do with a 401(K).
With a Roth IRA, you also do not have to make Required Minimum Distributions (RMDs), which means you can let more of your money keep growing over a longer period of time, Ramsey said.
But there are some limitations to the account which the finance guru warns Americans should know about.
It is crucial Americans understand the difference between a 401(K) and a Roth IRA before investing, Ramsey said
There are different advantages and disadvantages of 401(K) and Roth IRA accounts
There is a possibility you may not be eligible to put money in a Roth IRA if your income is above a certain threshold.
The account also has a five-year rule, Ramsey said, which means you will be penalized if you take money out of the account less than five years after you first contributed to it. You will also face a penalty if you withdraw cash from the account before you reach the age of age 59 1/2.
'You can only invest up to $7,000 in a Roth IRA in 2024 (or $8,000 if you're age 50 or older),' he added.
If you compare that to the 401(K) contribution limit which is $23,000 for 2024, that may seem like a small sum.
'That's why 401(k)s and Roth IRAs work better together,' he added.
When it comes to 401(K)s, the main advantages are the higher contribution limit - which is even higher for over 50s at $30,500 for 2024 - and the fact that you invest in the account with pre-tax dollars, which lowers your income tax bill.
'Probably the best thing about a 401(K) plan,' Ramsey said, 'is that your employer can match your investment up to a certain amount. That's a 100 percent return on your investment right off the bat.
'Matching isn't required by the government, so not all employers offer it. If yours does, make the most of it. Don't overlook free money!'
The Ramsey Show host is known for his blunt financial advice
But there are also various key disadvantages to a 401(K) plan, according to Ramsey.
There are fewer options for mutual funds, and you have to start withdrawing money from the plan once you reach a certain age or you will have to pay a penalty.
Ramsey warns that there is also a 'catch' to the tax breaks you get by investing in a 401(K).
'Since you fund a 401(K) with pretax dollars, you won't pay taxes now - but you will pay taxes on that money in retirement,' he said.
'This could lead to a pretty hefty tax bill depending on what tax bracket you're in when you retire.'
The finance guru is a big advocate for investing in both of these retirement accounts in order to reap the benefits of both.
Putting money away in a 401(K) and a Roth IRA means Americans can take advantage of an employer match, while also getting the tax benefits of a Roth IRA later in life.
