What is a Roth IRA vs 401k?
Let’s start with Roth IRA.
A Roth IRA, also known as an Individual Retirement Account, is a tax-advantaged investment account intended for retirement savings. A Roth IRA is best known for using after-tax dollars to contribute, and tax-free withdrawals. List of all features include:
- After-tax dollars contribution
- Contributions made at any time (during the year up until the tax date of the next year)
- Withdrawals are tax-free
- No age restrictions for contributions
- No mandatory distribution requirements
So…what’s a 401k?
A 401(k) is an employer-sponsored retirement savings plan that is a tax-advantaged investment account intended for retirement savings. A 401k is best known for allowing employees to make pre-tax contributions (lowering your taxable income) to a tax-deferred investment account. List of all features include:
- Allowing employees to make pre-tax contributions to a tax-deferred investment account
- Contributions can be conveniently deducted from paychecks automatically
- Employers typically offer some type of matching contribution program
- Withdrawals taxed as ordinary income at the time of withdrawal
- Higher contribution limits
This post is about what is a Roth IRA vs 401k.
The 7 advantages of Roth IRA.
1. Taxation
After-tax dollars.
2. Contributions
Contributions can be made anytime during the year up until the tax filing deadline for the contribution year. For example, any contributions for 2022 can be made starting from January 2022 until April 2023.
3. Tax-Free Withdrawals
Since the contributions are made with after-tax dollars, the earnings and contributions made to a Roth IRA are not subject to taxes during withdrawals. So if you had some significant growth throughout the years, fortunately, none of that is taxed!
4. No Age Restrictions for Contributions
Starting 2020, there are no age limits on making contributions to Roth IRAs.
5. No Required Minimum Distributions (RMD)
While typically retirement accounts require you to start taking withdrawals when you reach 72, Roth IRAs do not require withdrawals. That is until the death of the owner.
6. Vast Investment Options
Since Roth IRAs are individual retirement accounts, they are not tied to employers’ investment offerings. That means, you have the ability to choose which brokerage or platform to open a Roth IRA with, and choose what investments that brokerage offers.
7. No Limitation on Investment Options
You can still contribute to a Roth IRA even if you participate in a retirement plan at work.
The 7 advantages of 401k.
1. Taxation
Pre-taxed contributions to a tax-deferred investment account means you use money that hasn’t been taxed to contribute. Effectively, this reduces your taxable income (at the time of contribution).
2. Contributions
Depending on your employment situation, contributions can be conveniently deducted from paychecks automatically. So you don’t even have to worry about making the contributions. Set and forget it!
3. Employer’s Match
Again, depending on your employment situation, some employers offer some type of matching contribution program. This ultimately means free money. This is what people mean when they say don’t leave free money on the table.
4. Withdrawals
Remember when we said that the contributions are made with money that hasn’t been taxed yet? Well, that means the taxes are deferred until the you withdraw from the 401k.
5. Higher Contribution Limits
While a Roth IRA has a contribution limit of $6,500 (in 2023) per year, 401ks have a contribution limit of $22,500. That’s almost 4x the amount of a Roth IRA! Which means, you’re allowed to contribute up to $22,500 of your salary; effectively, reducing your taxable income by $22,500.
6. Loan Availability
With 401ks, there may be loan options, which allow you to borrow against your retirement savings during times of financial hardship/need. For example, while it’s not advised to do so, you have the option of borrowing from your 401k to purchase property.
7. Portable
Say you decide to leave a company, does your 401k stay with them? Of course not! You have the ability to transfer it to another retirement account. Check this post out for rolling over a 401k.
To reiterate, the benefits of a Roth IRA are:
- After-tax dollars contribution
- Contributions made at any time (during the year up until the tax date of the next year)
- Withdrawals are tax-free
- No age restrictions for contributions
- No mandatory distribution requirements
The benefits of a 401k are:
- Allowing employees to make pre-tax contributions to a tax-deferred investment account
- Contributions can be conveniently deducted from paychecks automatically
- Employers typically offer some type of matching contribution program
- Withdrawals taxed as ordinary income at the time of withdrawal
- Higher contribution limits
There you have it! Interested in learning more? Check this post out for the best index funds for Roth IRA.
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