Dave Ramsey warns Americans on retirement, 401(k)s and Roth IRAs

In the United States, when Americans are preparing for retirement, typically the first step they take is determining which investment vehicles they plan to use, which often include options like 401(k)s and Individual Retirement Accounts (IRAs).

Popular personal finance author Dave Ramsey advocates using both methods, yet encourages Americans to understand the benefits and drawbacks of each approach.

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Let's begin by clarifying the basics behind health insurance accounts and plans. We'll start with an overview of what each one entails and the key distinctions between them.

A 401(k) plan is typically offered by a company, where they may match the contributions that employees take out of their salary.

The funds deposited into a 401(k) plan are exempt from taxes until retirement, meaning employees won't owe taxes on that amount until they use those savings to cover living expenses in their post-work years.

A Roth IRA account allows an individual to invest in a retirement savings plan. Its primary benefits are two-fold: the account's earnings grow tax-free, and withdrawals are also tax-free once the retiree begins taking them out.

Some critics of 401(k)s point out that these retirement savings plans often have significant drawbacks. While 401(k)s provide a way for you to save for your retirement through your employer-sponsored plan at work, they can also create an anti-economic condition. Here are some of the disadvantages of a 401(k):
1. "Akin to a Certificate of Deposit, the people with higher balances in their 401(k) accounts... tend to behave economically more like a hand-to-mouth person who is living from one paycheck to the next."
2. It is double taxation, which can lead to 90% of the retiree's wealth being exhausted in just the first 10 years.

People who put money into 401(k) plans benefit from employer matching and are able to contribute larger sums than those who opt for Roth IRAs.

Ramsey stresses the significance of 401(k)s in a retirement plan, but he also highlights a few key drawbacks compared to Roth IRAs.

When an employee puts money into a 401(k) plan, they have a limited number of mutual fund options to invest in.

In an Individual Retirement Account with a Roth designation, investors have a wide range of investing options.

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With thousands of options at your disposal, you have a multitude of mutual funds to select from.

In the case of 401(k)s, as noted previously, any withdrawals made after a person retires are subject to taxation. Contributions made while building up the 401(k) are tax-free, but when it comes to using the funds to support one's retirement lifestyle, taxes become a factor.

The 401(k) also carries a penalty for withdrawing too late. Consequently, members are required to start withdrawing a portion of their savings no later than age 73 if they turned 72 in 2023 or later.

Dave Ramsey discusses other specifics about Roth IRAs.

The annual contribution limit for a Roth Individual Retirement Account (Roth IRA) is $7,000 for most individuals in 2024, while those 50 years of age or older can contribute up to $8,000.

When comparing that to the 401(k) contribution limit ($23,000 for 2024), you're probably thinking, 'Is that all?'

One important thing to note about Roth IRAs is that there's a penalty-free withdrawal rule. This is usually triggered after a specific holding period of five years from the first contribution made to the account.

Individuals who withdraw funds from their accounts prematurely will incur penalties and taxes. Specifically, there's a fee associated with withdrawing from a Roth IRA before turning 59-and-a-half. However, these consequences can often be sidestepped with careful planning.

Ramsey is a strong advocate for combining these two retirement investment strategies, encouraging individuals to invest in both types of accounts simultaneously.

By doing it this way, workers can enjoy the benefits of employer matching in the 401(k) plan, as well as the tax benefits associated with the Roth IRA.

Many corporations are introducing Roth 401(k) plans, which integrate the advantages of both types into a single plan.