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401 (k) vs. IRA vs. Brokerage account: How should you divide your assets?



The more you learn about personal finance, the more complicated your questions will get. But never fear: The hosts Robert Brokamp and Alison Southwick named their podcast Motley Fool Answers for a reason, and the October 29 episode – the monthly mail bag show – will co-host a whole bunch of money conundrums with some help from Motley Fool Wealth Management Director of Financial Planning Megan Brinsfield, CPA, CFP, and all-around fine human being.

In this segment, they respond to an email from Joshua, twentysomething who's wise is looking decades down the road and is starting to plan. But he is unsure if his strategy for directing half of the pension contributions to the IRA and half to the 401

(k) is the best ratio. Fools has some suggestions.

For full episodes of all The Motley Fools free podcasts, check out our podcast center. To get started investing, check out our quick start guide to investing in stocks. A full transcript follows the video.

This video was recorded on October 29, 2019.

Alison Southick: The next question comes from Joshua. "I'm in my mid-20s trying to figure out the ideal distribution between a 401 (k) and a Roth. I've heard that 50-50 is the best way to secure your bets, but since Roth is growing tax -free and 401 (k) doesn't, wouldn't Roth be much better for a youngster who expects significant pay growth? I'm thinking of going 30-70 or even leaning more toward Roth. "[19659002] Megan Brinsfield: I want to jump in here because Joshua is calling in a way to the twenties himself. Balancing taxable and Roth accounts …

Robert Brokamp: You thought about all that then, didn't you?

Brinsfield: I was also expecting substantial pay growth, so we're in the same boat, here. I think one thing that he is left out of these fines is the taxable broker and not just thinking in binary before tax or Roth. There are other tax-exempt pails as well.

So when it comes to 50-50 or other ratios, I actually look at about a third before tax, a third in Roth, a third in taxable form as the ideal relationship you build assets because it will bring the most flexibility when you leave.

That said, one thing many don't consider is the 401 (k) match. Let's say Joshua only saves in 401 (k) and that he shares his contribution between pre-tax and Roth. I'm just totally hypothetical here.

But your employer fight is always in dollars before taxes, so if he gets one to one match, there he actually uploads more into the pre-tax equation than the Roth equation, so if you get one for a match that adds up All in Roth, you will actually get 50-50 benefits on these buckets.

And then one of the things to keep in mind when building these Roth assets [is] is because I think people in their twenties can also be so attracted to the Roth lifestyle, they just want to put everything in there and pay the taxes now . I know my taxes are low and you are potentially missing out on these lower tax brackets that you can take advantage of in the future, because right now you're peeling off the top.

Every dollar you save before tax reduces the top tax bracket you are subject to; while in retirement life when I withdraw money, fill in the lower tax brackets first, and then I would not want to get to a place where I had everything in Roth, because then I missed the opportunity to get the 10% -15% dollars out in the future. I think a balanced approach is appropriate, and a third, a third, a third is what I want to go for.

Brokamp: And overall your salary will increase. According to David Blanchett at Morningstar, a college-educated individual's income is likely to be 50% higher when they retire than when they are 25, and that is adjusted for inflation. So someone who is very young will see significant salary growth as they get older, provided they are in some sort of professional job.

The other thing I would like to add is that we had the whole discussion about RMDs. When you have Roth assets, you do not have RMDs. If it is a Roth 401 (k), you must first transfer it to the Roth IRA, but then you do not have to worry about any of that mess if you have these Roth assets.


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