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A 401(k) and a Roth IRA
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December 13, 2000: 8:31 a.m. ET
After maxing your 401(k), consider a smaller amount for a Roth
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NEW YORK (CNNfn) - You're father of a two-year-old, putting away the maximum in your 401(k). Still, you worry that you're wasting other opportunities to save. You wonder whether you should put less in your 401(k) so you can open a Roth IRA.
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 Debra Morrison, a certified financial planner, answers questions on Your Money's viewer mail segment. |
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Debra Morrison, a certified financial planner from Fairfield, N.J., said a 401(k) may be a better option.
Morrison recently appeared on CNNfn's Your Money, and answered some questions for CNNfn.com about weighing a 401(k) against Roth IRAs and college loans.
Ron from Arizona writes: I'm a 37-year-old male, married with a two-year-old son. I earn $65,000 a year, and contribute $10,500 a year to my 401(k). The company matches $100 per month. The current balance is about $105,000. My wife does not work outside the home. Should I decrease my 401(k) and put money into a Roth IRA? I can't afford to do both. Can I contribute $4,000 a year to a joint Roth IRA, which means I would put $6,500 into my 401(k)? I know I give up some tax savings now, but the tax-free withdrawals of the Roth seem awfully enticing. Any recommendations for a good mutual fund for a Roth?
First of all, please remember that your contribution of $10,500 into the 401(k) does not cost you $10,500 because of the pretax nature of the contribution. In other words, a 401(k) pre-tax contribution of $10,500 in a 28 percent federal income tax bracket (state taxes not withstanding) costs only $7,560.
Every week, CNNfn.com brings you video from Your Money, where experts answer your questions about financial planning issues. If you have a question, you can e-mail the show at yourmoney@cnnfn.com.
So, perhaps you could consider putting the $2,940 tax savings into a Roth IRA. That's $2,000 for your wife, and the balance in your name, to better equalize the ownership of your assets, since you own the 401(k).
I typically recommend taking advantage of current tax relief realized in pretax contributions to your 401(k), rather than counting on the tax laws of the future; i.e., tax-free withdrawals from the Roth. Furthermore, the 401(k) offers tax-favored borrowing possibilities should you need temporary funds between now and retirement.
I would select a mutual fund that fills an investment gap that your 401(k) is weakest in. In other words, many 401(k)s do not offer superlative choices in all investment styles, capitalizations or markets -- growth, value, blend, or large, mid, and small-cap, and/or domestic and international.
Since the Roth IRA itself affords you tax advantages, do NOT invest Roth IRA funds in a municipal mutual fund. Figure out which sectors are covered best in your 401(k) sub-account choices, and then complement those with your Roth IRA investments.
Phil writes: I have about $50,000 in my 401(k), and more than $50,000 in outstanding student loans. I am only now paying down the balance, but it will take me years. Should I borrow money from my 401(k) to help accelerate the payoff of my student loans? You will want to weigh the comparative interest rates on your student loans with the loan interest rate from your 401(k).
Do you need help with your portfolio? E-mail experts at CNNfn.com at retirement@cnnfn.com.
Older student loans carried attractively low interest rates by comparison to other debt instruments. Since student loans are not always deductible, there may be an advantage to borrowing from your 401(k), and paying a net loan rate -- remembering that you are paying the loan proceeds back to yourself, and most 401(k) administrators only charge 1 to 2 percent for the loan privilege --to accelerate the student loan repayment process.
The main problem with a 401(k) loan is that the loan balance sub-account is generally relegated to fixed interest, and you would be losing the market performance that you would otherwise have on those loaned monies, had you been invested in a sub-account that may have afforded you capital appreciation.
Up to $2,000 of interest on a qualified student loan may be deductible in 2000. The interest deduction of $1,500 in 1999 was phased out for single filers with modified adjusted gross income between $40,000 and $55,000, or between $60,000 and $75,000 for marrieds filing joint.
The interest is not deductible if the taxpayer is claimed as a dependent on someone else's return or is married and filing separately. Finally, the interest deduction is not allowed after the first 60 months in which interest payments are required on the loan.You should proceed with the solution that makes the most sense mathematically, based upon the disparity in the interest rates, and what you think the markets will do going forward.
Finally, consideration needs to be paid to your anticipated longevity at your current company, since most 401(k) loans need to be repaid upon termination of employment. 
* Disclaimer
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