Becoming a Millionaire: Roth IRA vs 401K (What makes the MOST PROFIT)

What's up, guys? It's Graham here.

So, here's a question that's been coming up a lot recently, and this is a very confusing question for most people. That is this: What is better to invest in, a Roth IRA or traditional 401k?

Now, this is actually a somewhat complicated answer, and it's definitely not a one-size-fits-all approach. So, I figured I would just take the time to make this video to break down exactly which one would be best for you and which one is going to give you the most amount of money in the long run.

And seriously though, if you're at all confused about which one you should be investing in or which one would be better for you, just watching this video until the very end and understanding these concepts could save you tens of thousands or potentially even hundreds of thousands of dollars. And I pretty much guarantee that. I know it’s a bold claim to pretty much guarantee something like this, but trust me, if you watch this video until the very end and you smash that like button if you haven't already, because this video took me forever to do, you'll understand why.

So, let's first start with some background on the almighty Roth IRA. This is a retirement account where you can contribute and invest up to six thousand dollars per year with post-tax money. After the age of fifty-nine and a half, you can withdraw all of that money in that account and whatever profit you made completely tax-free. This means that you could potentially get decades upon decades of compound interest and growth or hundreds of thousands of dollars in profit without paying any taxes on those gains.

Now here are some of the benefits of doing this. The first one, like I just mentioned, is that all the profit you make in this account is completely tax-free after the age of fifty-nine and a half. That could save you a lot of money by the time you retire, especially if you begin investing in this early on.

Now secondly, with a Roth IRA, you can withdraw whatever money you contribute to that account at any time completely tax-free without paying any penalty. This means that if you contribute six thousand dollars to an account this year and, let's say, next year it grows to seven thousand dollars, well, you could still withdraw your initial six thousand dollars without paying any additional tax. You must, however, leave the profit you made in the account.

This gives you a lot of flexibility in the event that you need your money unexpectedly. However, unfortunately, there's no such thing as a free lunch, so these are some of the downsides.

The first thing with the Roth IRA is that you contribute what's called post-tax money, which is the money that you've made after you've already paid taxes on it. As we all know, the money that you have left over after you pay taxes is a lot smaller than before you had the taxes taken out of that. So that just leaves you with less money upfront to invest, all things considered.

Now secondly, if you want to take out your profit from this account prior to the age of fifty-nine and a half, you're going to be subject to a 10% penalty, and you're going to have to pay taxes on that money, which pretty much defeats the entire purpose of contributing to a Roth IRA in the first place.

Now third, the contribution limit to a Roth IRA is capped right now at six thousand dollars per year. So if you want to contribute more than that to this account, well, you can't.

But with that said, how does this all compare to a traditional 401k? The traditional 401k is an employer-sponsored retirement plan where you contribute pre-tax money into this account. This means you won't pay any taxes on the money that you contribute.

Now, because you don't have to pay any tax on the money you contribute to this account, this means that you have more money left over to invest instead of paying it to the IRS. With that extra money, you can then go and invest it to make you even more money.

Then, after the age of fifty-nine and a half, you could begin withdrawing the money that you have in a 401k, and you just end up paying the taxes you would have owed later at that time. So, basically, you're avoiding paying taxes on that money right now, just to end up paying it off later at the time you actually take it out of the account.

But the advantage to doing this is that you have more money left over upfront to invest with, so you have a larger amount working for you to make you even more money. Just like the Roth IRA, here are the positives of doing this.

The first and main benefit of doing this is that you contribute what's called pre-tax money, which means that this is money that has not been taxed. This is actually a pretty substantial tax write-off. So this means, for example, if you're in a thirty-two percent tax bracket and you contribute nineteen thousand dollars to a traditional 401k, this will save you six thousand eighty dollars in taxes.

This means an additional six thousand eighty dollars that you can then go and invest to work for you instead of paying that to the IRS. So secondly, you can contribute up to nineteen thousand dollars per year in a 401k, and that is more than three times higher than what you can do with a Roth IRA.

A third point: some employers are going to offer you what's called an employer match in a 401k. This is where they match you dollar for dollar for whatever you contribute into this account. Now, in terms of investment ROI, this is the best guaranteed risk-free 100 percent return on investment you will ever get in your entire life. Always do this, no matter what. At least always take the employer match and, at least, always smash that like button if you haven't already.

But now, for real though, at least promise me this is something you will do. This is one of the biggest benefits of contributing to a 401k – having the employer match. If you have this, always take advantage of it, no matter what.

But now, of course, with that said, unfortunately, there are some downsides with the 401k that I do want to mention. The first one is that even though you don't pay taxes on that money now and you save all of it, you're going to end up paying taxes on that money after the age of fifty-nine and a half whenever you take the money out of that account.

So with a 401k, hopefully, you're saving on taxes now when you're in a really high tax bracket to then withdraw it later on when maybe you're not making as much money in a lower tax bracket, and then you end up profiting that difference.

Now secondly, if you want to take out any of the money in a 401k prior to the age of fifty-nine and a half for anything other than financial hardship, you're going to be hit with a 10% penalty, and you're going to have to pay ordinary income taxes on that money, which is a lot higher than paying long-term capital gains because you've held that investment for a long period of time.

The third downside to see with this is that you're going to be forced to withdraw some of this money beginning at the age of seventy and a half, which, if you want to keep it in there and just let it continue growing, well, you can't.

So now, with all of that said, which one is actually the better option, and which one should you contribute to?

Let's first start with the Roth IRA. Now, since this is done with post-tax money, meaning you don't get any immediate tax deduction on the money you contribute to this account, this is best done when you're young in a low tax bracket and not already making a lot of money. Or, basically, it's better when you know you're gonna be making more money in the future.

Because of that, you're going to be in an even higher tax bracket. On the other hand, a Roth is not a good investment if you're making a ton of money right now in your prime earning years, and you expect to make less money by the time you retire.

Let's say, right now, you're running a business and that's making you $300,000 per year, but you know this is not going to last forever and you don't expect to really be making more than, like, $80,000 a year by the time you're 60. Well, in this case, you're in a high tax bracket now, but again, by the time you retire, you're gonna be in a much lower tax bracket.

So, in this case, it's smarter to take the 401k deduction at the higher tax bracket and then pay taxes on it by the time you're making less money in the lower tax bracket. Then you save that difference.

In my opinion, that's really how these accounts should be prioritized. The reality is that most people in retirement will not need as much income as they need right now. Potentially, by the time you retire, you're gonna have a paid-off home, and you're probably not going to be working full-time.

Because of that, you're not gonna need as much money to survive, and then because of that, you're gonna be in a lower tax bracket which is ideal for withdrawing your money from a 401k when you pay tax at that time.

For people in this position who are making a ton of money now but don't necessarily expect this to continue in the future, a traditional 401k could make a lot of sense, especially if you're in a thirty-two or thirty-four percent higher tax bracket and you expect to retire in a lower tax bracket.

However, there's also a very large percentage of people out there who expect to be ballin' in retirement and just making a ton of money. I expect to probably be one of those people, even though I'm currently in a ridiculously high tax bracket. I expect to make even more money in the future and I can't expect myself ever not to work and make money.

So, it kind of makes sense that I should contribute to a Roth first, knowing that in the future, if I make more money, I'm not gonna have to pay any additional taxes.

Now, another concern I have with prioritizing a traditional 401k is that we have no idea what the tax situation will look like 30 or 40 years from now. For example, the tax rates could be significantly higher than what they are right now, and if this is the case, you could end up paying way more taxes in the future than if you made the same amount of money today. That, of course, is very, very bad.

I just see it as being too many variables that could affect the potential tax rate positively or negatively in the future that none of us can predict.

So, given all of that information, here's my own personal recommendation of what I would do. And of course, this is not financial advice. For entertainment purposes only, that's my disclosure right there, so no one get upset. This is just my opinion. Do your own research on this, obviously, and don't listen to some person on YouTube.

So anyway, with that said, if it were me, if you're young and in a low tax bracket, the first thing you should do is prioritize the Roth IRA. You're not going to regret that when you're older, and I pretty much consider this a sure thing. Your tax-free money is going to be worth a lot more in the future.

On the other hand, if you're making a ton of money right now in a super high tax bracket and you don't expect that to last, and you expect to retire in a much lower tax bracket, then potentially you may want to prioritize the traditional 401k. Take the write-off now with the high tax bracket, withdraw the money in a lower tax bracket, and you'll be left over with more in the future.

The right mix between this, in my opinion, is probably just a balance between the two. I still contribute money to a traditional 401k just to hedge my options. I have no idea if it's going to be the smarter choice or the worst choice in the future, but I do it just in case as an option.

I also go pretty heavy with the Roth option as well because I know a hundred percent this is going to be tax-free in retirement, and I won't really have to question what the future tax rates might be, if they're higher or lower.

For anyone else also watching this, you can also look into what's called a Roth 401k. This is very similar to the Roth IRA, except with a higher contribution limit of nineteen thousand dollars per year. Of course, this works really well if you want more money to contribute with the Roth option beyond just a Roth IRA. This one works phenomenally well.

And if you're still confused on this, because honestly, this topic is extremely complex to explain, I'm including a calculator down in the description which will tell you how much money you would have left over with each option for your own tax bracket and income. For sure, definitely check that out.

And as always, you guys, thank you so much for watching. I really appreciate it if you made it to the very end. If you guys liked this video, make sure to smash that like button. Make sure to subscribe! Just hit that little subscribe button. It takes like a fraction of a second to do, and it's free. It puts three videos a week, so if you want to be a part of it, just subscribe.

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