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Ask Dave

One Before The Other

Dave has a very logical explanation for funding a Roth IRA and a 401k in a certain order.

QUESTION: Listener asks why you fund a Roth IRA prior to a 401k. Dave talks about the difference.

ANSWER: If you fund $500 a month into either of those in a decent growth-stock mutual fund averaging 12%, which is what the market has averaged since its inception, from age 30 to age 70, it will be worth $5.8 million. If you have that much in your account, and it’s in a 401k, you did not pay taxes on the money you put in, which was $240,000 of the $5.8 million. The rest of that is growth and you pay taxes on it.

If you do that into a Roth IRA, it’s tax-free growth. You pay taxes on the $240,000 in Roth IRA contributions, but not on the $5.5 million in growth.