Retirement Accounts

401(k) vs. Roth IRA

A Roth IRA and 401(k) both provide you tax-deferred growth on your contributions.

Stephanie Faris

Published February 3rd, 2021

Table of Contents

Key Takeaways

  • 401(k) and Roth IRA accounts tend to be the go-to retirement savings options.
  • With a 401(k), you can contribute more and there are no income limits, but you’ll have to pay taxes on the withdrawals when you retire.
  • A Roth IRA has income limits and allows you to only contribute $6,000-$7,000 each year.

If your employer offers a 401(k) retirement savings account, it’s usually wise to take advantage of it. You can have funds taken out of your account, pretax, reducing your taxable income each year. Some employers will even match your contributions up to a certain limit.

But once you’ve maxed out your 401(k), an individual retirement account (IRA) can be a good way to put additional money aside for retirement. When comparing a Roth IRA vs 401(k), the biggest variation is typically the way they’re taxed. There are a few other notable differences, though.

401(k) vs. Roth IRA

It’s important to save money for retirement. The longer you can contribute funds into retirement accounts the higher likelihood that you’ll see compounding growth over time. The two most popular retirement savings accounts are Roth IRAs and 401(k) accounts. To understand the difference between IRA and 401(k), though, it’s important to first look at their similarities.

A Roth IRA and 401(k) both provide you tax-deferred growth on your contributions. You’ll pay taxes on both accounts, but when you pay those taxes differs between the two.

The major difference in a Roth IRA versus a 401(k) account is how they’re taxed. With a 401(k), your employer takes money out of your paycheck and funds your retirement savings before taxes have been deducted. This can be a plus as it decreases your taxable income during your working years.

A Roth IRA, on the other hand, is not an employer-based retirement account but instead purchased through a broker or lender. You put the money in out of your own checking or savings account after it has already been taxed. When you make account withdrawals in retirement, those will come out tax-free.

What is a 401(k)?

A 401(k) is an employer-sponsored retirement savings account. Designed to serve as an employee benefit, these accounts let employees opt in to have money taken out of each paycheck to fund retirement. A 401(k) is pre tax versus a Roth 401(k), which has you put the money in after taxes have been taken out.

Both a 401(k) and Roth IRA are designed to fund retirement. But with a 401(k), you’ll pay taxes when you take the funds out. One of the biggest benefits of a 401(k), though, is the higher contribution limit. For 2021, you can contribute up to $19,500 (or $26,000 if you’re 50 or older). With a Roth IRA, that limit is much lower, at $6,000 (or $7,000 if you’re 50 or older).

What is a Roth IRA?

What is the difference between an IRA and a 401(k)? While you’ll usually get your 401(k) through your employer, a Roth IRA is something you seek out on your own. You can set up a Roth IRA through a lender, in person or online, or go through a brokerage. A Roth IRA doesn’t let you put your income in before taxes have been paid on it.

IRAs are ideal for those who don’t earn six figures. You won’t be able to contribute the full amount if you earn above the income threshold. At higher income levels, you won’t be able to contribute at all to a Roth IRA. However, high earners may pay lower taxes in retirement, so the Roth IRA’s benefit of paying taxes now could hurt you, forcing you to pay more in taxes than you’d pay when you’re no longer in the workforce.

Key Differences

There are several key differences in Roth vs 401(k). But in addition to when you pay taxes, your income will play a key role in which option is better for you.

For high earners deciding between a Roth IRA or 401(k), a 401(k) will typically be the best option. Roth IRAs have income limits, while 401(k) accounts don’t. If you earn $140,000 above (or $208,000 if you’re married filing jointly), you won’t be able to contribute to a Roth IRA at all.

But if you earn more than $125,000, you’ll still be impacted by income limits that could make your 401(k) or Roth IRA choice a little easier. Single filers who earn more than $125,000 but less than $140,000 are subject to income phaseouts with a Roth IRA, which simply means you won’t be able to contribute the full amount. If you’re a joint filer, that phaseout range starts at $198,000.

Header401(k)Roth IRA
Taxes on contributionsFunds are deposited pre-taxFunds are deposited after tax
Taxes on distributionsWithdrawn funds are taxed as ordinary incomeQualified withdrawals are tax-free
Required minimum distributions (RMDs)Must begin taking funds out by age 72No required minimum distributions
Contribution limits (for 2021)$19,500 (or $26,000 for those age 50 and over)$6,000 (or $7,000 for those age 50 and over)
Income limits (for 2021)No income limits$140,000 for single filers and $208,000 for joint filers

Final Thoughts

If you’re choosing between a Traditional 401(k) and Roth IRA, your own special circumstances determine which is best. We recommend consulting a Certified Financial Planner® who can look at your income, employer-provided retirement savings options, and retirement goals and help you decide which option is best for you.

Retirement Accounts

Understanding 401(k)s

401(k) Rules

Cashing Out your 401(k)

Understanding Roth 401(k)s

Roth IRA Basics

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Author

Stephanie Faris

Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a writer for a credit card processing service and has written about finance for numerous marketing firms and entrepreneurs. Her work has appeared on Money Under 30, The Motley Fool, MoneyGeek, E-commerce Insiders, and GoBankingRates.

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