ASK KIM
Roth vs. 401(k)
by Kimberly Lankford

My daughter has finally been hired on with a company that has a 401(k) plan, but her company does not match or contribute to the plan. She is 27 years old, married, makes roughly $30,000 a year and does not have any other savings. Would a Roth IRA be better for her than an unmatched 401(k)?

It's generally best to invest in a 401(k) up to the employer match; otherwise, you'd be passing up free money. But when there is no match, we'd go with the Roth first, particularly because of your daughter's low tax bracket.

She can invest up to $4,000 this year in a Roth IRA, and the cap will rise to $5,000 in 2008. If she wants to save more, then she could contribute to her 401(k) after funding the Roth. Investing in a Roth won't lower your daughter's taxable income, as contributing to a 401(k) will. However, she can withdraw money from the Roth tax-free once she turns 59½.

Investing $4,000 in the 401(k) would save her just $600 in the 15% tax bracket. But she'd pay an awful price later. Assuming that $4,000 earns 8% per year, it will grow to about $65,000 over 35 years. Taking that much out of a 401(k) would cost almost $10,000 in tax, assuming she's still in the 15% bracket -- and even more if she's in a higher bracket.

If she uses a Roth instead, her tax bill on $65,000 will be $0 -- no matter what bracket she's in.