- CNBC's Jim Cramer exposes the good, bad and ugly when dealing with 401(k) and IRA contributions.
- Roth or no Roth? That is the question. The "Mad Money" host tries to answer it.
According to CNBC's Jim Cramer, it does not matter how good an investor is at picking stocks. If the funds are kept in the wrong account, tons of money could be wasted in hidden fees and opportunity could be missed.
This logic is especially applicable to 401(k) and IRA retirement accounts, and whether it makes sense to use a Roth account.
"I think that, aside from the earned income tax credit, the Roth IRA may be the single greatest thing our government has done for low-income families since the end of the war on poverty, which at best, ended kind of in a draw, [with] poverty possibly winning on points," the "Mad Money" host said. "If I were the king of the forest, I'd make the limits for the IRA investing the same as the ones for the 401(k)."
When deciding among a Roth IRA, 401(k) or a traditional account, it depends on whether it makes more sense to pay income tax now or to wait and pay income tax after retirement. This is a complicated decision that has more to do with the specifics of a situation and whether one anticipates they will be in a higher tax bracket at retirement.
With a Roth, contributions are made with after-tax income and the money in the Roth IRA will not be taxed again. There is also an income limit, depending on whether you file jointly or as a single. According to the IRS, contributions to traditional and Roth accounts cannot exceed $6,000 for individuals under age 50 and $7,000 for those over 50.
As long as the cash remains in the Roth account, you will not pay dividend tax. The money can be withdrawn without a penalty at any time, as long as it's in a Roth account.
Another perk to a Roth IRA is that after five years, money contributed — not your gains — can be withdrawn without the usual 10% penalty. This is very different from a regular IRA, where there are no taxes on contributions until money is withdrawn.
"For anyone whose marginal tax rate is 25% or less, which is most of America, I think you go with Roth. Better to take the hit up front, then allow your Roth IRA to compound tax free for the rest of your life," Cramer said.
The same rule applies to a 401(k); however it is important to note that the contribution limits for this type of account are much higher than for an IRA. In 2016, the IRS set a contribution limit of $19,000. Unlike a Roth IRA, there are no income limits for a Roth 401(k).
"The less money you make, the more likely that a Roth is for you. Yes, it's that simple," Cramer said.