Roth IRA vs. 401(k): Which Is Better for You?

Senior African Couple Getting Retirement Financial Advice at the Dining Room Table.
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Planning for your retirement is undoubtedly one of the best financial decisions you can make. If you’re looking to start saving for your retirement, then you’re faced with a decision to make. Will you choose a Roth IRA plan or a 401(k) plan? Both plans are similar in that they offer tax benefits and will help you grow your wealth over time, but there are key differences to note.

Ideally, it would be best to have both accounts to save your retirement investments for maximum benefits. If you’re exploring the Roth IRA vs. 401(k), though, learning about the features of each account can go a long way in enabling you to make an informed decision.

What Is a 401(k)?

A 401(k) plan is a retirement savings plan offered by many U.S. employers. With a 401(k) plan, you can make an investment that’s a percentage of your income, or you can choose to contribute a specific amount every month. It’s important to note that these investments are made with pre-tax money, which means your investment is taken from your paycheck before the income is taxed.

Retire Comfortably

The major advantage of 401(k) plans is that your employer can choose to match your investment up to a specific amount. This is not a requirement by the government, so not all employers offer it. If your employer offers 401(k), check if they match contributions so you can make the most out of your money. Another significant benefit is that all the money you invest is yours, so you can convert your 401(k) account to a Roth IRA if your company goes under or you choose to move on.

Advantages of a 401(k)

The following are significant advantages of a 401(k).

Employer Matches

This is one of the key advantages of 401(k)s. If your employer matches your 401(k) contributions, ensure that you take advantage of it. In most cases, the match is a percentage of your contribution or a specific percentage of your income.

Retire Comfortably

High Contribution Limits

401(k)s have significantly higher contribution limits than Roth IRAs. With 401(k)s, you can invest up to $20,500 per year, excluding the employer match. If you’re 50 years or older, you’re allowed to invest an additional $6,500 a year, bringing the total to $27,000.

Tax Breaks

When you contribute to a 401(k), you get a tax break because you’re allowed to deduct your contributions when filing your income tax return. This way, you save money because your taxable income is reduced. 401(k)s are structured in a way that you will pay your taxes later when you start making withdrawals, known as distributions. Distributions are subject to income taxes at the current tax rate at that time.

Disadvantages of a 401(k)

While a 401(k) plan is a great option to save for retirement, there are a few drawbacks you need to know.

Limited Investment Options

With a 401(k) plan, your employer hires a third-party investor who is in charge of the company’s retirement plan. In that scenario, the administrator chooses the mutual funds you can invest in, limiting your investing options.

Required Minimum Distributions

You’re not allowed to leave money in your 401(k) plan forever. Once you hit 72, you are required by law to withdraw a certain amount of your savings every year, or you’ll be charged a penalty. And if you withdraw the money before age 59 ½, you’ll incur a penalty.

What Is a Roth IRA?

A Roth individual retirement account is slightly different from a 401(k) in that individuals with no employer involvement can open an account. Another significant difference between the two plans is that with Roth IRAs, you contribute to the account with after-tax money. Like a 401(k), Roth IRA accounts allow your savings to grow with your after-tax money. 

If you’re self-employed or work for small companies that do not offer 401(k) plans, a Roth IRA account might be your perfect option. You can also have a Roth IRA account even if you already have a 401(k) plan. It wouldn’t hurt to save extra money and diversify your investments, especially since you have more freedom with IRAs.

Advantages of a Roth IRA

Here’s a few reasons why you might want to choose a Roth IRA.

Investments Grow Tax-Free 

The greatest advantage over 401(k)s is that since you contribute to your Roth IRA with taxed money, the growth isn’t subject to taxation, and you won’t have to pay taxes when making withdrawals at retirement.

More Freedom With Investment Options

With Roth IRAs, no administrators decide the funds you can invest in, meaning you can choose whatever mutual funds you like. However, make sure you seek advice and understand how different funds work before making your investment.

Offers Spousal IRA

If you are married, but only one spouse earns an income, the working spouse can also open a Roth spousal IRA account for the non-working partner. The earning spouse can invest in both accounts, unlike 401(k)s, which can only be opened by people earning an income.

Disadvantages of Roth IRAs

When it comes to disadvantages, the Roth IRA has only one: lower contribution limits, compared to a 401(k). Roth IRAs allow investments of up to $6,000 per year or $7,000 if you’re 50 years of age or older.

Good To Know

When comparing 401(k)s and Roth IRAs, putting your investing goals at the forefront is crucial. For example, if you have employment income, a 401(k) might be a great option. Otherwise, you can’t go wrong with a Roth IRA.

Roth IRA vs. 401(k): What’s the Difference?

The significant difference between 401account(k) and Roth IRA is how they are taxed. With Roth IRAs, your investments grow tax-free since you invest after-tax dollars. With 401(k) plans, you invest before-tax money, which lowers your taxable income per year. Here’s a quick summary of the key differences between the two plans.

Feature 401(k) Roth IRA
Eligibility Available through employer programs only. In most cases, there’s a waiting period before one is enrolled. You must have earned income to open a Roth IRA account. Restrictions come in after a certain income depending on your filing status. Married couples can open a spousal IRA if only one partner earns income.
Taxes Investments are made with pre-tax dollars, so your taxable income for the year is lowered. You’ll have to pay taxes on the money you withdraw in retirement. Investments grow tax-free since they are made with already taxed dollars. No taxation on withdrawals in retirement.
Contribution Limits $20,500 each year or $27,000 per year for people who are 50 or older. Highly compensated employees have access to additional contribution limits. $6,000 per year or up to $7,000 for people aged 50 and above.
Employer Contribution Most employers can match contributions based on a percentage of your gross earnings. No employer matches.
Required Minimum Distributions (RMDs) At 72 years, you are required to take out a certain amount to avoid penalties. The money can sit in the account for as long as you live.
Investment options The account is controlled by third-party administrators, so investment options are limited. Wider variety of options and more freedom on how to invest and the assets you’d like to have in your portfolio.

Final Take

Roth IRAs and 401(k)s are popular options since they allow your retirement savings to grow tax-free. However, they have distinct differences in terms of investment options, tax treatment and employer contributions. Taking a close look at both plans will let you see the apparent discrepancies. The choice you make today will help you save thousands of dollars in preparation for your retirement. Once you understand how they work, you can then go with a plan that will maximize your savings.

Choosing between Roth IRA vs 401 (k) can be overwhelming for many people, but that shouldn’t be the case anymore. If you work for an employer that offers a 401(k) plan, you should take advantage of the opportunity. 

If you’re self-employed or work for small businesses with no 401(k) plans, opening a Roth IRA account is a wise financial move. The best-case scenario would be to take advantage of both plans because you get the benefits of your employer match and the tax benefits of a Roth IRA.

401(k) vs. Roth IRA FAQs

Here are the answers to some questions about contributing to 401(k)s versus Roth IRAs.
  • What’s the difference between a Roth IRA and 401(k)?
    • A Roth IRA is a retirement plan that allows you to contribute after-tax dollars, thus growing your investment tax-deferred. On the other hand, a 401(k) is an employer-sponsored plan that allows pre-tax contributions, meaning it will reduce your retirement income.
  • Is it better to have a 401(k) or Roth IRA?
    • 401(k) plans usually tend to be better for those earning high incomes. Additionally, they have a higher contribution limit compared to Roth IRAs and allow your employer to make matching contributions.

Our in-house research team and on-site financial experts work together to create content that’s accurate, impartial, and up to date. We fact-check every single statistic, quote and fact using trusted primary resources to make sure the information we provide is correct. You can learn more about GOBankingRates’ processes and standards in our editorial policy.

About the Author

Lydia Kibet is a freelance writer specializing in personal finance and investing. She's passionate about explaining complex topics in easy-to-understand language. Her work has appeared in GoBankingRates, Investopedia, Business Insider, The Motley Fool, and Investor Junkie. She currently writes about investing, banking, insurance, real estate, mortgages, credit cards, loans, and more. Connect with her on Twitter or moneycredible.com.

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