A Roth IRA offers post-tax contributions, more investment flexibility, and tax-free withdrawals. A 401(k) offers pretax contributions, limited investments, and taxed withdrawals.
You have many options for ways to save toward retirement. If you’re looking over the options your employer offers, you might be evaluating a Roth IRA vs. 401(k). Here’s a look at how these account types work, their tax advantages and how they play into a total retirement saving strategy to help you decide what’s best for you.
Roth IRA vs 401(k): Overview
Both a Roth IRA and a 401(k) will help you save for retirement and offer investment options. However, a 401(k) offers tax advantages now, while a Roth IRA offers tax advantages during retirement. Here’s a deeper look at how each account works and its pros and cons.
Roth IRA
While some workplaces offer a Roth IRA, most do not. IRA stands for individual retirement account, indicating that you can set up one for yourself. You’ll pay taxes on the money before placing it in the account, but when you withdraw funds from the account during retirement, that money is not taxable.
Here’s a look at some of the pros and cons of these accounts.
Pros
- Can help reduce your tax burden during retirement by keeping you in a lower tax bracket
- Tax-free growth on your retirement savings
- You are not required to take minimum distributions at any point
- You can withdraw the funds at any time without penalties
- Offers diverse income in retirement
Cons
- No tax advantages at the time of placing the funds in the account
- If you make more than the income limit, you can’t contribute
- You have to wait until age 59.5 to withdraw earnings tax-free and the account must be at least five years old
- The $7,000 maximum annual contribution limit ($8,000 if you’re 50 or older) is lower than other account types
401(k)
You may be familiar with 401(k) plans because they are the most common employer-sponsored retirement account types. These accounts allow you to contribute pretax dollars toward retirement. With a $23,000 per year contribution limit and catch up contributions of $7,000, once you reach age 50, you can contribute far more than an IRA.
Here are some important pros and cons to consider regarding 401(k) accounts.
Pros
- Some employers offer matching contributions to help bolster your savings
- Account maintenance is simpler than other plan types
- Save on taxes now since contributions are pretax
- Larger contribution limits
- Some employers offer a loan option to help with hard times or large purchases
Cons
- You can’t control or manage the fees the account charges since your employer chooses and manages it
- If you’re in a higher tax bracket in retirement, you’ll ultimately pay more in taxes
- Fewer investment options compared to other retirement plans
- Withdrawal penalties for taking funds before age 59.5
Roth IRA vs 401(k): Eligibility & Contribution Limits
With a 401(k), the largest eligibility consideration is whether your employer offers the account. If so, consider matching to decide how much to contribute to maximize your savings.
An IRA is available to everyone since anyone can open an account. Find an institution that makes sense for you and get started.
A 401(k) allows you to save up to $23,000 annually until you reach age 50. Then you can make catch up contributions of $7,000 annually, bringing your total annual limit to $30,000. And if your employer makes matching contributions, those do not count toward your annual limit, though your total contribution cannot exceed your salary or $69,000 for those under age 50 or $76,000 for those age 50+, whichever is less. In contrast, Roth IRA contributions top out at $7,000 per year until you reach age 50 when you can contribute a total of $8,000 annually.
Roth IRA vs 401(k): Tax Treatment & Distributions
Tax treatment is one of the largest differences between a 401(k) vs. Roth IRA. The funds you place in your 401(k) are pretax, meaning you can lower your tax burden in the year you make contributions. But the funds you place in a Roth IRA are after-tax.
When you take distributions from your Roth IRA, you won’t pay taxes on the funds since you’ve already paid taxes. This can be a strategy to keep your retirement income within a lower tax bracket because the funds you draw from a 401(k) are taxable.
You must start taking required minimum distributions (RMD) from your 401 (k) at age 73, but a Roth IRA has no rules about when you must take distributions.
You cannot withdraw money from your 401(k) without a 10% penalty until age 59.5. A Roth IRA allows for penalty-free withdrawals once the account has been open for five years.
Roth IRA vs 401(k): Investment Options
With a Roth IRA, you’re in full control of your investments. You can manage the account or set up a robo-advisor account that helps you choose your asset allocation. This can allow you to invest in mutual funds or ETFs that charge lower fees to help you maximize your savings.
A 401(k) has limited investment options based on your employer's offer. Generally, these are limited to a small set of investments.
When is a 401(k) a Better Retirement Savings Option?
A 401(k) is a better retirement savings option when your employer provides matching contributions. You should contribute enough to max out matching contributions to increase your savings. It’s also wise to use a 401(k) to reduce your tax burden in that tax year if you’re on the cusp of a higher tax bracket.
When is a Roth IRA a Better Retirement Savings Option?
A Roth IRA is a better option when you’ve maxed out your employer’s contribution plan or when you believe your retirement income tax bracket will be higher than your current tax bracket. Since withdrawals are post-tax, it offers diversified income, it’s a wise choice to add to your retirement plan lineup.
Roth IRA vs 401(k): At a Glance
| Roth IRA | 401(k) | |
| Contribution limit | $7,000 until age 50 when catch up contributions allow for a total of $8,000 | $23,000 until age 50 when catch up contributions allow for a total of $30,000 |
| Tax break in current calendar year | No | Yes |
| Withdrawal taxation | Tax-free | Taxed at your retirement tax bracket rate |
| Income limit | High income can reduce contribution limits | None |
| Opportunity for employer matching contributions | No | Yes, for a maximum of $69,000 when combined with your contributions or $76,500 once you are 50+ |
| Payroll deduction option | No | Yes |
| Withdrawal age without penalties | Once the account has been open for five years for your contributions; before age 59.5 for earnings | 59.5 |
| Required minimum distributions | None | The later when you reach age 73 or retire |
| Account fees | Minimal | Higher based on your employer’s selections |
| Investment options | Vast | Generally, few based on your employer’s decisions |
| Who provides maintenance | You | Employer |
Can You Have a Roth IRA and a 401(k)?
You can have a Roth IRA and a 401(k). In fact, it is smart to diversify your income during retirement and max out all types of retirement contributions.
Diversifying Your Retirement Savings
For the most part, the question isn’t whether you should have a 401(k) or Roth IRA. The question is how to maximize both accounts to manage your tax burden now and during retirement. Combining the benefits of both accounts allows you to maximize your savings and income now and later.
Frequently Asked Questions
Is it better to put money in a 401k or Roth IRA?
It’s better to put money in your 401(k) to maximize your employer matching contributions. Once you’ve maxed that out, it’s wise to place funds in a Roth IRA since it offers more investment options and alternative tax benefits.
Why is the Roth IRA better?
A Roth IRA allows you to contribute after-tax dollars, offers more investment options, and offers greater flexibility to withdraw funds before age 59.5 without penalties.
Is 401k better than Roth for high income?
Yes, a 401(k) is better than a Roth IRA for high-income earners because the IRS sets income limits that could make you ineligible to contribute to a Roth IRA.
About Rebekah Brately
Rebekah Brately is an investment writer passionate about helping people learn more about how to grow their wealth. She has more than 12 years of writing experience, focused on technology, travel, family and finance. Her work has been published in Benzinga, Hearst Bay Area, FreightWaves and Dallas Observer publications.