Roth IRA beats 401(k) in key ways

Dear Dr. Don,
I am 24 and put 10 percent of my income into my 401(k). If my company does not match my 401(k) contribution, am I better off contributing that money to a Roth IRA?
-- Regina Retirement

Dear Regina,
Your ability to contribute to a Roth IRA account in 2008 is determined by your income. Here's what IRS Publication 590, "Individual Retirement Arrangements," has to say about the income restrictions:

For 2008, your Roth IRA contribution limit is reduced (phased out) in the following situations.

• Your filing status is married filing jointly or qualifying widow(er) and your modified AGI is at least $159,000. You cannot make a Roth IRA contribution if your modified AGI is $169,000 or more.
• Your filing status is single, head of household, or married filing separately and you did not live with your spouse at any time in 2008 and your modified AGI is at least $101,000. You cannot make a Roth IRA contribution if your modified AGI is $116,000 or more.
• Your filing status is married filing separately, you lived with your spouse at any time during the year, and your modified AGI is more than -0-. You cannot make a Roth IRA contribution if your modified AGI is $10,000 or more.

The modified AGI, or MAGI, limits for the 2009 tax year will be a few thousand dollars higher than the 2008 numbers. The publication "IRS Announces Pension Plan Limitations for 2009" puts a finer point on it if you're bumping up against these MAGI limits.

Assuming you're eligible to contribute to a Roth IRA, you still have to decide if the Roth is the better choice. Both the Roth IRA and the 401(k) plan are tax-advantaged accounts. With the Roth, you contribute after-tax dollars today, and qualified distributions coming out of the account aren't subject to federal income taxes.

With a 401(k) plan, you contribute pretax dollars today, and qualified distributions out of the account are subject to federal income tax at your ordinary income rate. Being able to borrow money from the plan is an advantage to the plan versus the Roth IRA, but the loan has to be repaid if you leave your company. Otherwise, it is counted as a distribution from the plan and subject to income tax and possibly a penalty tax if it is an early distribution.

While there is no loan program available for a Roth IRA account, you contributed after-tax dollars, so no income tax is due on withdrawals of your contributions. You can withdraw your original contributions for any reason and at any time without taxes or penalties.

However, early distribution of investment earnings can be subject to income taxes and may be subject to a 10 percent penalty tax. The age of the account matters. Distributions from accounts less than 5 years old are treated differently than accounts that are more than 5 years old.