The Motley Fool: Is 401(k) your best option?

Don’t assume that your single best bet for retirement savings is your 401(k), 403(b) or 457 plan. Economists Laurence J. Kotlikoff and Jagadeesh Gokhale, for example, think that many investors would have more money in retirement if they contributed to accounts other than 401(k)s. That’s because withdrawals from 401(k) accounts are taxed as ordinary income instead of at the lower capital gains rates for long-term holdings. The withdrawals can also push retirees into higher tax brackets. Qualified Roth IRA withdrawals, meanwhile, are tax-free.

If your employer matches your retirement plan contributions, you should contribute enough to take full advantage of that free money, according to Kotlikoff and Gokhale. After that, you’re probably better off putting your next dollars into a Roth IRA, if you’re eligible, to the maximum allowed. (If your employer doesn’t offer a match, you might contribute the maximum amount to a Roth IRA before even considering another option.)

Here are two other Roth benefits:

“Assets in an employer-sponsored plan (and in a traditional IRA, for that matter) must start being distributed by the time the account owner turns 70 1/2, whether the money is needed or not. The account owner loses the benefit of tax-deferral on money withdrawn. With a Roth IRA, however, if the money isn’t needed, it can continue to grow, tax-free, no matter how old you get.

“Withdrawals from work plans and traditional IRAs before the account owner is age 59 1/2 result in immediate taxation and a 10 percent penalty. Some plans allow participants to borrow from their plans, but many don’t. Contributions to (but not earnings in) a Roth IRA may be withdrawn anytime, penalty- and tax-free. The same can be said of earnings withdrawn for first-time home purchases as long as the money has been in the account for at least five tax years. This isn’t always a smart thing to do, but if you need the money, it’s there.

Of course, everyone’s situation is different. Learn much more at www.fool.com/retirement.htm and www.irs.gov, or ask a financial adviser.

Ask the Fool

Q: What’s this “2 percent floor” I’ve heard of in tax lingo? – H.H., San Ramon, Calif.

A: It refers to the fact that your miscellaneous itemized deductions need to exceed 2 percent of your adjusted gross income in order to be of any value. If they do exceed it, the only sum you’ll be able to deduct is the amount by which they exceed the 2 percent.

For example, if your AGI is $50,000, your floor will be 2 percent of that, or $1,000. If your miscellaneous itemized deductions total $820, you can’t do anything with them. But if they total $1,500, you can deduct $500. Costs that may qualify include certain home office expenses, tax-preparation fees, investment-related fees, job-hunting expenses and job-related expenses.

Learn much more about taxes in our Tax Center at www.fool.com/taxes and from the horse’s mouth at www.irs.gov. Get answers to your tax questions on our Tax Strategies discussion board at http://boards.fool.com/ Messages.asp?bid=100155.

Q: In an earnings report I recently read, I saw a profit of $1.25 per “diluted” share. What is a diluted share? – R.M., St. Augustine, Fla.

A: A company’s bottom-line profit, or “net income,” is divided by its number of shares to arrive at its earnings per share, which is frequently reported in two ways, as “basic” and “diluted.”

Basic EPS is based on the number of shares that currently exist, while diluted EPS is more conservative, taking into account shares that could exist, because of people exercising existing stock options, for example. Other securities that could be converted into common stock are also accounted for.

When looking at a firm’s EPS, focus on diluted, not basic numbers.