Dave Ramsey warns Americans on retirement, 401(k)s and Roth IRAs
Many American workers planning for retirement first decide which types of investments to use, and these typically include 401(k)s and Individual Retirement Accounts (IRAs).
Renowned personal finance expert Dave Ramsey favors a combination of both methods, but advises Americans to be aware of the pros and cons of each approach.
It's helpful to have a basic understanding of what these accounts and plans are, and exactly how they compare to one another.
An Employer Sponsored 401(k) Plan is often where the employer matches the contributions made by employees from their paychecks.
The funds contributed to 401(k) plans are put on hold in terms of taxes, so workers won't have to pay taxes on those dollars until retirement when those savings are used for everyday living costs.
A Roth IRA account is another type of retirement account where an individual invests their money. The main distinguishing feature of a Roth IRA is two-fold: the money grows tax-free, and the account also allows for withdrawals to be taken tax-free once the worker has retired.
Dave Ramsey talks about some drawbacks of using 401(k)s.
Individuals who invest in 401(k) plans benefit from employer matching contributions and can contribute larger sums compared to the contribution limits of Roth IRAs.
Ramsey notes that 401(k)s are a fantastic element of a person's retirement plan, but he also identifies some drawbacks in comparison to Roth IRAs.
One, employees contributing to a 401(k) plan have fewer investment options in mutual funds to select from.
In a Roth Individual Retirement Account, individuals have many more investment opportunities.
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There are thousands of mutual funds to pick from, including options that align with your investment goals and risk tolerance, allowing you to choose the one that best fits your needs.
In addition to the point mentioned earlier, it's worth noting that withdrawals made from a 401(k) after retirement are subject to taxation. When contributions are made to the 401(k) while building it up, they're made with pre-tax dollars. However, it's when those funds are used to support retirement living that taxes come into play.
The 401(k) also has a penalty for early withdrawal. So people must start withdrawing some of their savings by age 73 if they were born in 1950 or later.
Dave Ramsey has insights on other Roth IRA dissimilarities.
For the year 2024, the amount you can invest in a Roth IRA is limited to $7,000 for general individuals. However, people who are 50 or older have an even higher limit of $8,000.
There's a key difference between a Roth and a 401(k), so it's all about how they're stacked up against one another. When you put those contribution limits together ($23,000 for 2024 with a 401(k)), you might be thinking, ‘That’s it? That’s as many funds as can be saved? Yep. That’s why combining a 401(k) and a Roth IRA is often optimal.
One more drawback of Roth IRAs is that you can't withdraw money from your account for five years after your initial contribution.
Individuals who withdraw money from their accounts before their due date will be subject to penalties and taxes. Additionally, there is a penalty for taking money out of a Roth IRA before age 59 and a half, although these can often be avoided through careful planning.
Ramsey endorses combining these two retirement investment approaches. He recommends investing in both.
He explains that, that way, workers can get the benefits of their employer matching contributions to the 401(k) plan as well as the Roth IRA's tax benefits.
Many American companies are now offering Roth 401(k) plans, which combine the advantages of both types in one plan.
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