Roth IRA vs 401(k): What's the Difference? (2024)

Roth IRA vs 401(k): What's the Difference? (1)

When it comes to saving for retirement, you have a ton of options to choose from. Do you open a traditional IRA or a open a Roth IRA? Both can help you save for retirement, but while a 401(k) is a tax-deferred plan offered through a workplace, a Roth IRA is an individual plan where you pay taxes on money before it goes in. A good place to start is simply to familiarize yourself with the retirement options that you have. For more help with retirement planning and other financial issues, consider working with a financial advisor.

Roth IRA Definition

A Roth IRA is an individual retirement account (IRA) that you set up with a financial institution, like a bank or investment firm. You fund Roth IRAs with your after-tax money, which means you can’t deduct your contributions at tax time. However, when it comes time to withdraw your savings during retirement, that income isn’t taxable.

A Roth IRA differs from a traditional IRA which you fund with pre-tax money. You then pay regular income taxes on your traditional IRA withdrawals during retirement.

401(k) Definition

You may be more familiar with 401(k) plans. These are the plans that employers sponsor, meaning you don’t have to open and fund one by yourself. You contribute to a 401(k) by designating a portion of each paycheck to go toward your plan. Since you fund a 401(k) with pre-tax income, you pay taxes on that money when you make withdrawals during retirement.

It’s important to note that 401(k) plans can also come with an employer match program. Employers can choose to match an employee’s contribution, often up to a certain percentage of the employee’s income. The exact terms of the match will depend on each employer. A common example of this match program includes an employer matching 50% of an employee’s contribution, up to 6% of the employee’s salary. Luckily, your employer match does not count toward your 401(k) limit.

Roth IRA vs 401(k)

Roth IRA vs 401(k): What's the Difference? (2)

On the surface, Roth IRAs and 401(k)s don’t have too much in common except offering a tax-advantaged way to save for retirement.

Since a 401(k) is employer-sponsored, you don’t have to be as hands-on with managing the account as with an IRA. But since you can have both a Roth IRA and a 401(k), it can help to note their differences and similarities. That way you can optimize each account and your savings.

Eligibility & Contribution Limits

Your eligibility for a 401(k) plan simply depends on whether your employer offers one. Generally, you have to inquire a little bit more about taking advantage of an employer match program.

On the other hand, without an employer’s help, a Roth IRA may not prove available to everyone. For one, you have to find an institution with which to open your account. Some institutions may only accept applicants with high deposit amounts, limiting their products to more wealthy clients.

It’s important to note, however, that Roth IRAs offer a solid savings option for those with lower income. This is because you fund a Roth IRA with after-tax money, making your withdrawals tax-free. This structure comes in handy for people who see themselves in a higher tax bracket in retirement.

Plus, Roth IRA rules and limitations tend to phase out higher earners. For tax year 2024, total contributions to Roth (and traditional) IRAs cannot exceed $7,000, or $8,000 for those 50 and older. Those numbers were $6,500 and $7,500 respectively, in 2023.

401(k) plans, on the other hand, have much higher contribution limits.

For tax year 2024, you can contribute up to $23,000 (or $30,500 for those 50 and older) to your 401(k). For tax year 2023, the limit was $22,500 and $30,000. Don’t forget that if your employer matches your 401(k) contribution, their match does not count towards that limit. Instead, you have to ensure your total annual 401(k) contributions do not exceed the lesser of 100% of your salary or $69,000 ($76,500 for those 50 and old) in 2024.

401(k) vs. Roth IRA: Tax Treatment & Distributions

A big difference between Roth IRAs and 401(k)s lies in their tax treatment. You fund Roth IRAs with after-tax income, meaning your withdrawals are not taxable retirement income. Conversely, you fund 401(k)s with pre-tax income. This makes your 401(k) withdrawals subject to taxation in retirement.

When it comes time to make withdrawals in retirement, or distributions, you must start taking required minimum distributions (RMDs) from your 401(k) starting at age 73. RMDs allow the IRS to start taxing those funds. But since a Roth IRA holds after-tax funds, the IRS doesn’t need to tax it again. Therefore, you don’t need to take RMDs from a Roth IRA.

Plus, if you’re under the age of 59.5 and you’ve had a Roth IRA for at least five years, you can withdraw your contributions at any time. The same does not apply to 401(k) plans, however, where you face a 10% penalty on withdrawals before you reach age 59.5. You also still have to pay income tax on early withdrawals, which can severely hurt your savings.

Investment Options

Finally, Roth IRAs and 401(k)s differ in their investment options. With a 401(k), you are limited to the investment options your employer has chosen. The size of the pool you can choose from will depend on your employer, but generally, you cannot choose any investment you fancy.

A Roth IRA provides more control over your investment accounts. Since you (or a robo-advisor) manage the account, you get to choose the asset allocation of your account. That may give you more space to choose low-cost mutual funds and ETFs instead of possibly paying high fees for your employer’s choices.

Roth IRA401(k)
EligibilityTends to favor people in lower tax bracketsDepends on whether the employer offers one
Contribution Limits
  • Total contributions cannot exceed $7,000 for 2023 and $6,500 for 2022.
  • Total contributions for those ages 50 and older cannot exceed $8,000 for 2024 and $7,500 for 2023.
  • Self-contributions cannot exceed $23,000 for 2024 and $22,500 for 2023
  • .
  • Self-contributions for those ages 50 and older cannot exceed $30,500 for 2024 and $30,000 for 2023.
  • Total contributions cannot exceedthe lesser of 100% of your salary or $69,000 for 2024 ($66,000 for 2023)
  • Total contributions cannot exceed $76,500 for those ages 50 and older ($73,500 for 2023)
Tax Treatment
  • Funded with after-tax income
  • Withdrawals are not taxable
  • Funded with pre-tax dollars
  • Withdrawals are taxable income
Distributions (Withdrawals)
  • No required minimum distributions
  • Withdraw contributions at any time if you’re under the age of 59.5 and you’ve had the Roth IRA for at least five years
  • Withdraw earnings at any time if you’re over the age of 59.5 and you’ve had the Roth IRA for at least five years
  • Required minimum distributions begin at age 73
  • Early withdrawals result in 10% penalty fee + income tax
Investment Options
  • You (or your advisor) choose your investments
  • If you work with an advisor, you may be limited to their own selection
  • Limited to employer’s selection
Employer Match?NoYes

Bottom Line

Roth IRA vs 401(k): What's the Difference? (3)

Now that you know more about Roth IRAs vs. 401(k) plans, you can better make decisions regarding your retirement savings. Plus, the differences between these plans make them ideal partner accounts. You can have a 401(k) through your employer and a Roth IRA with a financial institution of your choosing, provided they offer Roth accounts. Then in retirement, you’ll have both taxable and nontaxable income to withdraw.

Tips on Getting Ready for Retirement

  • The most important part about saving for retirement is that it’s never too early to start! True, retirement may not be on many 20-somethings’ minds, but the earlier you start saving, the more money you can have in retirement.
  • Once you’ve started saving for retirement, try not to compare yourself to your neighbors wondering if your savings are normal. It’s more important to tailor your savings plans to your own current financial situation and your retirement goals.
  • Retirement planning can be complex and overwhelming, but a financial advisor can help demystify the process. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

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Roth IRA vs 401(k): What's the Difference? (2024)

FAQs

Roth IRA vs 401(k): What's the Difference? ›

With a Roth IRA, you generally have a large number of investments to choose from, including stocks, bonds, cash alternatives, and alternative investments. With a Roth 401(k), you are limited to the investment options offered by your employer's 401(k) plan.

What are the differences between Roth IRA and 401 K? ›

Both can help you save for retirement, but while a 401(k) is a tax-deferred plan offered through a workplace, a Roth IRA is an individual plan where you pay taxes on money before it goes in.

What's the difference between a 401(k) and an IRA? ›

The main difference between 401(k)s and IRAs is that 401(k)s are offered through employers, whereas IRAs are opened by individuals through a broker or a bank. IRAs typically offer more investment options, but 401(k)s allow higher annual contributions.

What is the main difference between a 401k and a Roth IRA quizlet? ›

A Roth IRA grows tax free and is a better option than the 401(k), which grows tax-deferred.

What is one of the main differences between a Roth IRA? ›

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.

Why traditional 401k is better than Roth? ›

If you think your tax rate will be higher, paying taxes now with Roth contributions makes sense. If your tax rate is likely to be lower in retirement, you can use traditional contributions to defer taxes instead.

Can you withdraw from Roth IRA? ›

You can withdraw contributions you made to your Roth IRA anytime, tax- and penalty-free. However, you may have to pay taxes and penalties on earnings in your Roth IRA.

What are the pros and cons of a Roth IRA? ›

Roth individual retirement accounts (IRAs) offer several key benefits, including tax-free growth, tax-free withdrawals in retirement, and no required minimum distributions (RMDs). One key disadvantage: Roth IRA contributions are made with after-tax money, meaning there's no tax deduction in the years you contribute.

At what age is 401k withdrawal tax-free? ›

Once you reach 59½, you can take distributions from your 401(k) plan without being subject to the 10% penalty. However, that doesn't mean there are no consequences. All withdrawals from your 401(k), even those taken after age 59½, are subject to ordinary income taxes.

Can I have both 401k and Roth IRA? ›

Yes, you can — but double check the rules to make sure you're optimizing your retirement savings.

What is a major advantage of the Roth over a 401k? ›

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.

Why does Roth IRA have the best tax advantages? ›

With a Roth IRA you contribute after-tax money to the account, so you don't get to avoid tax on your contributions, as you might with a traditional IRA. In exchange, your money grows tax-free and you'll be able to withdraw it tax-free at retirement, defined as age 59 ½ or older.

What is the first ingredient to building wealth? ›

Building wealth over time requires an understanding of how to invest wisely, safeguard assets, and manage debt. The first step is to earn enough money to cover your basic needs, with some left over for saving.

What is the difference between a Roth IRA and a 401k? ›

Key Takeaways

Contributions to a 401(k) are tax deductible and reduce your taxable income before taxes are withheld from your paycheck. There is no tax deduction for contributions to a Roth IRA, but contributions and earnings can be withdrawn tax free in 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.

Is it better to max out 401k or Roth IRA? ›

If you don't have enough money to max out contributions to both accounts, experts recommend maxing out the Roth 401(k) first to receive the benefit of a full employer match.

Can I contribute full $6,000 to IRA if I have a 401k? ›

If you participate in an employer's retirement plan, such as a 401(k), and your adjusted gross income (AGI) is equal to or less than the number in the first column for your tax filing status, you are able to make and deduct a traditional IRA contribution up to the maximum of $7,000, or $8,000 if you're 50 or older, in ...

Do you claim a Roth 401k on taxes? ›

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!

Is Roth 401k better than after-tax 401k? ›

Like a Roth 401(k), earnings grow tax-deferred. However, unlike a Roth 401(k), the earnings on the account are taxed upon withdrawal. The after-tax option predates the Roth 401(k). Of course, if you are saving for retirement and wish to do it on an after-tax basis, the Roth 401(k) is preferable to the after-tax option.

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