Roth 401(k) vs. Roth IRA: Which is better for you? (2024)

FAQs

Roth 401(k) vs. Roth IRA: Which is better for you? ›

Roth IRA matchup, a Roth IRA can be a better choice than a 401(k) retirement plan, as it typically offers more investment options and greater tax benefits. It may be especially useful if you think you'll be in a higher tax bracket later on.

A big advantage that the Roth 401(k) has over the Roth IRA is the possibility of an employer matching your contributions up to a certain percentage. Employer matches are the closest thing there is to “free money,” so if you're deciding between a Roth 401(k) vs. a Roth IRA — keep this in mind.

The biggest benefit of the Roth 401(k) is this: Because you already paid taxes on your contributions, the withdrawals you make in retirement are tax-free. That's right! The money you put in—and its growth! —is all yours. No taxes will be taken out when you use that money in retirement.

With a Roth IRA, you contribute after-tax dollars, your money grows tax-free, and you can generally make tax- and penalty-free withdrawals after age 59½. With a Traditional IRA, you contribute pre- or after-tax dollars, your money grows tax-deferred, and withdrawals are taxed as current income after age 59½.

The key difference between Roth and traditional individual retirement accounts (IRAs) lies in the timing of their tax advantages. With traditional IRAs, you deduct contributions now and pay taxes on withdrawals later; Roth IRA contributions are made with money that's been taxed, so you get tax-free withdrawals later.

No tax deferral now. The list of cons may be short for Roth 401(k)s, but missing tax deferral is a big one. When faced with a choice of paying more tax now or later, most people choose to pay later, hence the low participation rates for Roth 401(k)s.

With a Roth 401(k) you'll make contributions with after-tax money, so you won't enjoy a tax break today. In exchange, any money that you withdraw in retirement will be tax-free. In a Roth 401(k), you'll enjoy not only tax-free growth of your investment gains but also tax-free withdrawals.

Tax diversification: High-income earners often find themselves in higher tax brackets. A Roth 401(k) account gives you more flexibility in managing your tax liability during retirement. Having a Roth account also allows you to be strategic about the tax treatment of your investment choices.

Contributions and earnings in a Roth 401(k) can be withdrawn without paying taxes and penalties if you are at least 59½ and had your account for at least five years. Withdrawals can be made without penalty if you become disabled or by a beneficiary after your death.

Earnings can't be withdrawn tax-free until age 59½ and the account is at least 5 years old. Diversification in retirement, so all of your accounts aren't tax-deferred. The maximum contribution is relatively low compared with a 401(k). You'll probably need other accounts to save enough for retirement.

How much will a Roth IRA grow in 10 years? ›

Let's say you open a Roth IRA and contribute the maximum amount each year. If the base contribution limit remains at $7,000 per year, you'd amass over $100,000 (assuming a 8.77% annual growth rate) after 10 years. After 30 years, you would accumulate over $900,000.

A general guideline is that if you think your tax bracket will be higher when you retire than it is today, you may want to consider a Roth IRA—especially if you're younger and have yet to reach your peak earning years.

The primary benefit of a Roth IRA is that your contributions and the earnings on those contributions can grow tax-free and be withdrawn tax-free after age 59½, assuming the account has been open for at least five years.

"Unfortunately, the income limits on Roth IRAs make it difficult for many higher-income individuals to contribute directly to these accounts," said Hayden Adams, CPA, CFP^®, director of tax and wealth management at the Schwab Center for Financial Research.

Higher contribution limits: In 2023, you can stash away up to $22,500 in a Roth 401(k)—$30,000 if you're age 50 or older. Roth IRA contributions, by comparison, are capped at $6,500—$7,500 if you're 50 or older. Matching contributions: Roth 401(k)s are eligible for matching contributions from your employer, if offered.

Roth IRAs might seem ideal, but they have disadvantages, including the lack of an immediate tax break and a relatively low maximum contribution.

In the case of a Roth 401(k), you contribute with after-tax dollars. So, your employer would include your contributions in box 1 from your W-2. Whether you own a traditional or Roth 401(k), as long as you didn't take out any distributions, you don't have to do a thing on your federal or state return!

A Roth IRA is meant for retirement savings, while a taxable brokerage account is better for investing money that you may need before retirement. It can also be a good way to supplement your retirement savings if you're already maxing out your retirement accounts.

Tax diversification: High-income earners often find themselves in higher tax brackets. A Roth 401(k) account gives you more flexibility in managing your tax liability during retirement. Having a Roth account also allows you to be strategic about the tax treatment of your investment choices.