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Roth IRA vs. 401(k): Which One Is Right for You?

Sandy Guidicianne, Director, First Republic Bank
September 17, 2021

Saving for retirement can be an overwhelming and stressful process. The array of savings options can be confusing, especially if you’re not completely sure of the differences between each of them.  

But saving enough money for retirement doesn’t have to be daunting. Two of the most common choices for retirement are Roth IRAs and 401K accounts, understanding the difference a Roth Individual Retirement Account (IRA) and a 401(k) is a vital part of your savings strategy. Here's how a Roth IRA and a 401(k) differ, the pros and cons of each and how to choose the best option for you.  

​​An overview of retirement savings accounts

There are several reasons why you might not be sure which retirement account is right for you. The sheer variety of accounts, their tax implications and the way in which they’re managed all vary. Plus their names tend to be fairly similar as well. Here are four of the most common retirement savings accounts: 

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Traditional IRA

Roth IRA

401(k)

Roth 401(k)

Management

Individual

Individual

Employer

Employer

Contributions

Pre-tax

Post-tax

Pre-tax

Post-tax

Withdrawals

Taxed

Tax-free

Taxed

Tax-free

 

IRAs and 401(k)s share a significant amount of overlap in terms of how they’re named, managed and taxed. The differences between them come down to when you pay taxes on the money and who manages how the money gets invested.

401(k)s plan options (or investment options) are managed by employers, whereas IRAs are managed by individuals. Traditional IRA and 401(k) contributions aren’t taxed when you add money to the account; instead, you’re taxed on your withdrawals. Roth IRAs and 401(k)s are funded with money that’s already taxed as income, which means you don’t pay taxes on what you withdraw later on. 

Roth IRA benefits and disadvantages

There are several advantages, as well as a few potential downsides, to saving for retirement with a Roth IRA account. Knowing how these accounts work can help you decide if it’s the right fit for your portfolio. 

Roth IRA benefits 

There are several key advantages to Roth IRA accounts within your retirement plan:

  • Savings: Earnings are income-free since you pay taxes on your contributions up front. 

  • No minimum distribution: Traditional IRAs require you to take minimum distributions beginning at age 72. Roth IRAs don’t have this requirement.

  • Access to funds: You can withdraw money from your Roth IRA before you retire. Withdrawals on your contributions do not come with a penalty, although withdrawing earnings can.

  • Keep taxable income low in retirement: Roth IRAs and Roth 401(k)s can reduce your overall tax liability in retirement.

Roth IRA disadvantages

A Roth IRA may not work for your financial strategies if the below are true for you:

  • ​​Taxes: Taxes get paid upfront with a Roth IRA, so you won’t be able to make tax deductions with your contributions. 

  • Contribution limits: Roth and traditional IRAs have a max of $6,000 per year ($7,000 for those 50 years or older).

  • Setup: Require setting up and managing a Roth IRA yourself, which may not be ideal if you don’t want to manage money on your own. Working with an Eagle Invest advisor is one way to mange the setup and management of your Roth IRA. 

  • Income limits: For 2021, as a single filer, you cannot make a modified adjusted gross income (MAGI) of more than $140,000 if you want to contribute to a Roth IRA, or no more than $208,000 if you are married and filing jointly.  
    • For higher income earners who are priced out of a Roth IRA, there are potentially other ways to contribute to one. To learn more this process, reach out to your Eagle Invest advisor.

401(k) benefits and disadvantages

401(k) plans also come with their own pros and cons. If your employer offers a managed 401(k) plan, you may want to consider how this retirement option works within your retirement plans.

​​401(k) benefits

There are several upsides to using a 401(k) plan to help fund your retirement, including:

  • Employer matching: Your employer has the opportunity to match your contributions, meaning more money put into your 401(k).

  • High annual contribution limits: For 2021, the max contribution for a 401(k) was $19,500 or $26,000 if you’re over the age of 50.

  • Education and support: Some bigger investment companies have online resources and advisors to help with investment management.

401(k) disadvantages

There may be disadvantages to opening and funding a 401(k) account, however. These include:

  • Fewer investment options: Your employer chooses how many investment options to provide, which may lead to less customization for you.

  • Potentially higher account fees: As the employee, you will have little control over what you pay in account fees.

  • Fees on early withdrawals: Typically, if you withdraw from your 401(k) before the age of 59.5, you will have to pay ordinary income tax on the withdrawals, plus a 10% penalty.   

Is it better to invest in a Roth IRA or 401(k)?

Since Roth IRAs and 401(k)s come with their own distinct pros and cons, the right option for your portfolio is different for everyone. The good news is that you’re not limited to one or the other; rather, you can open both a Roth IRA and participate in your company’s 401(k) plan at the same time.

When choosing your retirement contributions, if your employer offers matching contributions, look at your employer-sponsored plan first before looking at IRAs. Some 401(k) plans may offer a Roth component. If your plan does, consult with your financial advisor on the best way to allocate retirement contributions. For people who want to self-manage, they may want to open an IRA so they can purchase whole universe of investments, so that is a benefit over employer-managed.

The ideal investment option is to invest in both a Roth IRA and a 401(k). Invest in your 401(k) up to the matching limit to ensure you are taking advantage of your employer’s investment. Then, invest in a Roth IRA up to the contribution limit, since Roth IRAs have more flexible investment options and tax benefits that will help your retirement savings in the long-run.  

If you’re looking to make the most of your retirement income, taking advantage of these accounts is one major way to get ahead. To learn more about your options, reach out to one of our financial experts at Eagle Invest to help answer your questions and create a tailored retirement plan.

The strategies mentioned in this article may have tax and legal consequences; therefore, you should consult your own attorneys and/or tax advisors to understand the tax and legal consequences of any strategies mentioned in this document. This information is governed by our Terms and Conditions of Use.