What is a Roth IRA vs 401k? - Welcome to Wealth & Wardrobe (2024)

FAQs

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

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.

Traditional 401(k)s are tax-deferred accounts, which means you fund your account with pretax dollars and pay taxes on your distributions in retirement. Roth 401(k)s are funded with post-tax money, and you don't pay any taxes on your distributions in retirement.

High earners may be unable to make direct contributions to a Roth individual retirement account (Roth IRA) due to income limits set by the Internal Revenue Service (IRS). A loophole, known as the backdoor Roth IRA, provides a way to get around the limits.

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

If you file taxes as a single person, your Modified Adjusted Gross Income (MAGI) must be under $153,000 for tax year 2023 and $161,000 for tax year 2024 to contribute to a Roth IRA, and if you're married and filing jointly, your MAGI must be under $228,000 for tax year 2023 and $240,000 for tax year 2024.

A Roth IRA offers tax-free investment growth and no RMDs, but there are bigger limits on contributions, and you don't get a tax benefit today. A traditional 401(k) offers the opportunity to put away more and get a tax benefit today, but you will owe taxes later when you withdraw and must take RMDs.

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.

"Saving in a Roth 401(k) could be a better way to go if the taxes on a Roth IRA conversion are prohibitive." 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.

So, say you're leaving your job for a different position, and your new employer offers a 401(k) plan. You can roll over your old 401(k)'s funds into a new 401(k) account, if your new employer allows this, according to the IRS. Or you can roll over your old 401(k) to an IRA.

I know you're shocked to be reading that the tax code is being exploited by some gazillionaire to avoid paying their fair share. But let's look at how a Roth IRA has turned into the go-to vehicle for sheltering billionaires' billions in appreciation.

Do millionaires use Roth IRAs? ›

But the tax incentives that the new accounts provided weren't lost on the rich or their accountants. In recent decades, with the advent of the Roth IRA and relaxed restrictions on IRA rollovers, ultrawealthy Americans have reportedly built tax-sheltered accounts worth many millions—or even billions—of dollars.

The tax argument for contributing to a Roth can easily turn upside down if you happen to be in your peak earning years. If you're now in one of the higher tax brackets, your tax rate in retirement may have nowhere to go but down.

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.

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 can be withdrawn tax free in retirement. Retirement distributions from 401(k)s are taxed at ordinary income tax rates.

A Roth IRA is an account that allows you to save a certain amount each year for retirement. But what makes a Roth IRA one of the best retirement savings options is that it includes tax-free growth and tax-free withdrawals once you retire. A 401(k) is a retirement savings plan that's sponsored by an employer.

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.

So, to sum it all up: Your best choice is to invest in your 401(k) up to the employer match and then open up a Roth IRA—and make sure you reach your goal to invest 15% of your gross income in retirement. Always seek good advice and invest in good growth stock mutual funds with a history of strong returns.

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

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.