Roth IRA vs. 401(k) – How to Decide

Sandy Guidicianne, Director, First Republic Private Wealth Management
September 17, 2021

  • Roth IRAs offer flexibility on investment choices and can provide tax-free income in retirement.
  • You may be able to maximize your earnings on 401(k)s thanks to your employer matching your contribution.
  • Ideally, you should prioritize investing in your 401(k) to take advantage of employer matching and then contribute to your Roth IRA afterward.

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 money can be less daunting with a thorough understanding of the options at your disposal.

But saving enough money for retirement doesn’t have to be daunting. Roth Individual Retirement Account (IRAs) and 401(k) accounts are two of the most common choices for retirement savings. 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.   

What are the differences between IRAs and 401(k)s?

One of the biggest differences between 401(k) plans and IRAs is that 401(k)s are managed by employers, whereas IRAs are managed by individuals. Other differences include the variety of the investments and the tax implications of each.

Traditional IRA and 401(k) contributions aren’t taxed when you add money to the account; instead, you’re taxed on your withdrawals. In contrast, Roth IRAs and Roth 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.

These differences may contribute to why you might not be sure which retirement account is right for you. Here are four of the most common retirement savings accounts:  

  Management Contributions Withdrawals of Qualified Distributions
Traditional IRA Individual Pre-tax Taxed
Roth IRA Individual Post-tax Tax-free
Traditional 401(k) Employer Pre-tax Taxed
Roth 401(k) Employer Post-tax Tax-free

As the table suggests, 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.

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 many reasons a Roth IRA accounts can be beneficial to your retirement plan:  

  • Savings: Earnings in Roth IRAs are tax-free since contributions are made with after-tax dollars.
  • 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 don’t come with a penalty, although withdrawing earnings can.  
  • Keep taxable income low in retirement: Contributions to Roth accounts can reduce your overall tax liability in retirement.  

Roth IRA disadvantages

However, there are several reasons 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: Must either be set up on your own (which may not be ideal if you don’t want to manage money or investments) or with the help of a financial advisor.
  • Income limits: For 2022, as a single filer, you can’t make a modified adjusted gross income (MAGI) of more than $144,000 if you want to contribute to a Roth IRA, or no more than $214,000 if you are married and filing jointly.     
Contributing to a Roth IRA as a High-Income Earner
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 2022, the max contribution for a 401(k) is $20,500 or $27,000 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, depending on your situation. 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)?

One option is to invest in both a Roth IRA and a 401(k), provided you meet the qualifications. 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 can help your retirement savings in the long run.  

However, you may want to focus your investment strategy on one retirement savings account to take full advantage of its benefits. Consider these circumstances when a Roth IRA or a 401(k) may be the better option:

  • When a Roth IRA may be ideal: You want to have full control over what investments are in your retirement savings account.
  • When a 401(k) may be ideal: You want to take advantage of your employer’s contribution or your 401(k) option offers a Roth component.

Withdrawals from Traditional 401(k)s and IRAs are subject to ordinary income tax and may be subject to a 10% penalty if the account owner is under age 59 1/2. Withdrawals of earnings from Roth 401(k)s and IRAs are tax-free provided the account owner is over age 59 1/2 and, for the Roth IRA, the account has been open for 5 years. Otherwise, withdrawals of earnings may be subject to ordinary income taxes and a 10% penalty.

If you’re looking to make the most of your retirement income, taking advantage of one of these accounts is one way to get ahead. If you are curious about all of your options, reach out to one of our financial professionals at Eagle Invest; they can advise you and help answer any questions you have as you create your retirement plan.

Eagle Invest is an investment advisory service offered by First Republic Investment Management, Inc., and sub-advised by BlackRock FutureAdvisor, Inc. (FutureAdvisor). First Republic Investment Management, FutureAdvisor and Fidelity Investments, Member FINRA/SIPC, are unaffiliated SEC-registered investment advisors. FutureAdvisor is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. $5,000 minimum investment required.

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