When it comes to retirement planning, two of the most popular options are 401(k)s and Roth IRAs. Both accounts offer tax benefits, but there are some key differences between the two that could make one a better choice for you than the other.
Key Differences Between 401(k)s and Roth IRAs
| Feature | 401(k) | Roth IRA |
|---|---|---|
| Contribution limits | Higher (up to $22,500 in 2023, plus catch-up contributions for those 50 and older) | Lower (up to $6,500 in 2023, plus catch-up contributions for those 50 and older) |
| Tax treatment | Contributions are made pre-tax, so you get a tax break now. Withdrawals are taxed as ordinary income. | Contributions are made after-tax, so you don’t get a tax break now. Withdrawals are tax-free. |
| Investment options | Usually limited to a set of funds chosen by your employer. | More investment options available, including stocks, bonds, and mutual funds. |
| Employer match | Some employers offer a matching contribution, which can boost your savings. | No employer match. |
| Early withdrawal penalties | Yes, unless you meet certain exceptions. | No, you can withdraw your contributions at any time without penalty. |
| Required minimum distributions (RMDs) | Yes, you must start taking withdrawals at age 72. | No, you can leave your money in the account for as long as you want. |
Which Account Is Right for You?
The best retirement account for you depends on your individual circumstances. Here are a few things to consider:
- Your current tax bracket: If you’re in a low tax bracket now, a Roth IRA may be a better choice, as you’ll get the benefit of tax-free withdrawals in retirement. If you’re in a high tax bracket now, a 401(k) may be a better choice, as you’ll get a tax break on your contributions now.
- Your expected tax bracket in retirement: If you expect to be in a higher tax bracket in retirement, a Roth IRA may be a better choice, as your withdrawals will be tax-free. If you expect to be in a lower tax bracket in retirement, a 401(k) may be a better choice, as you’ll have already paid taxes on your contributions.
- Your investment goals: If you want more investment options, a Roth IRA may be a better choice. If you’re looking for a more hands-off approach, a 401(k) may be a better choice.
- Your employer’s matching contribution: If your employer offers a matching contribution, a 401(k) may be a better choice, as you’ll get free money from your employer.
Additional Considerations
In addition to the factors above, there are a few other things to keep in mind when choosing between a 401(k) and a Roth IRA:
- Income limits: There are income limits for Roth IRAs. If you earn too much, you may not be able to contribute to a Roth IRA.
- Early withdrawal penalties: There are early withdrawal penalties for 401(k)s. If you withdraw money from your 401(k) before age 59½, you’ll have to pay a 10% penalty, plus income taxes.
- Required minimum distributions (RMDs): There are required minimum distributions (RMDs) for 401(k)s. Once you reach age 72, you must start taking withdrawals from your 401(k) each year.
Choosing between a 401(k) and a Roth IRA is a personal decision. The best account for you depends on your individual circumstances. Consider the factors discussed above to make the best decision for your retirement savings.
Is a Roth 401(k) Better Than a Roth IRA?
FAQ
Why Roth IRA instead of 401k?
What is a major advantage of the Roth over a 401k?
What is the downside of a Roth IRA?
Why is Roth better than traditional 401k?
What is the difference between a Roth 401(k) and a IRA?
A Roth 401 (k) has higher contribution limits and allows employers to make matching contributions. A Roth 401 (k) is overseen by your company which selects the broker and may limit investment options. A Roth IRA allows your investments to grow for a longer period, offers more investment options, and makes early withdrawals easier.
Can a Roth IRA be used as a 401(k)?
Roth IRAs and Roth 401 (k)s can both help you get tax-free income in retirement. While Roth IRAs have income restrictions, everyone with access to a Roth 401 (k) through work can contribute to one. You can potentially save more per year using a Roth 401 (k) due to higher contribution limits and an employer match (if offered).
How much can a Roth IRA contribute to a 401(k)?
The annual contribution limits are much smaller with Roth IRA accounts than for 401 (k)s. For 2023, the maximum annual contribution for a Roth IRA is: $6,500 if you’re under age 50. $7,500 if you are age 50 or older. The Roth IRA limits your contributions based on earned income.
Can you have a Roth IRA and a 401(k) at the same time?
Many, if not most, retirement investors can contribute to both a Roth IRA and a 401 (k) at the same time. “You can and should have both a Roth IRA and a 401 (k),” says Gregory W. Lawrence, a certified financial planner ( CFP) and founder of retirement planning firm Lawrence Legacy Group.