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Chapter 9. IRAs Versus 401(k)s—Which Is ... > When Using Both a 401(k) and IRA Mak... - Pg. 93

IRAs Versus 401(k)s--Which Is Better? 93 These IRAs allow the beneficiary to withdraw money without paying any income or penalty taxes if the money is used for qualifying higher education expenses. Education IRAs can be established by you to benefit a family member or even a friend, as long as that person is under the age of 18. Beginning in 2002, the most that can be contributed to a person's education IRA is $2,000 (vs. the old $500 limit). The $2,000 that you contribute to your education IRA does not reduce your IRA contributions. No tax deductions are allowed for the contributor. For 2002, if you make more than $110,000 (single) or $220,000 (couple), you are out of luck. Be careful. When Using Both a 401(k) and IRA Makes Sense With all these new types of IRAs available, it might appear that some of them could replace your 401(k). Before you make any major decisions, understand all the facts: · Deductible IRA vs. 401(k)?A tax deduction on an IRA will generally have less of an effect than a pre-tax 401(k) deduction. Why? Because a 401(k) gives you the tax savings with each pay- check. With an IRA, you have to wait until you file your taxes to get the tax benefit. Meanwhile, your 401(k) tax savings have been invested all year long. Also, remember that you cannot borrow money from your IRA for long periods of time; you can do so in most 401(k)s. · Roth IRA vs. 401(k)?This is a bit trickier, given the tax-free feature in a Roth IRA. In almost all cases, staying in your 401(k) until you have maxed out your yearly allowable contribution still makes the most sense. Using a Roth IRA means that you are betting that your tax rate will be equal to or higher in retirement than it is now (that is, you'll pay taxes at your current tax rate on the money that you put into a Roth IRA today vs. your 401(k) money that won't be taxed until you retire). Use a Roth IRA to replace after-tax contributions that you are making to your 401(k). Why? Earnings on your after-tax contributions are taxed at income rates. With a Roth IRA, you pay no tax after age 59½. · Education savings accounts (Ed IRAs) vs. 401(k)?The Ed IRA's tax-free feature is enticing. Also valuable are the higher income limits for married couples and the flexibility to use these monies for public or private kindergarten through graduate school expenses. So, in comparison, Ed IRAs beat 401(k)s hands down. An even better choice might be a Section 529 plan, also known as qualified state tuition program. There are two types of 529 plans: prepaid tuition plans and savings account plans. We recommend the savings account plan because you can save more (up to $10,000 per year) and you have investment flexibility. Some states even offer a state income tax deduction. Go to or for more in- formation on these plans. You are not restricted from claiming the Hope and Lifetime Learning Credits in the same tax year as Ed IRA or Sec. 529 distributions. Our Advice Stay with your 401(k) until you have maxed out your yearly contributions (plan limit or $11,000). After that, consider a deductible IRA.