Which retirement savings account is better for you, the Roth IRA or 401K?
The short answer is that it doesn’t really matter because they are both great tax-advantaged tools for helping you save money for retirement. And it really depends on your situation and your preferences when trying to decide which is truly best for you. Below I’ll try and present the facts about the two types of retirement accounts and let you do the deciding.
Again, the short answer is just to get started with one or the other (or both!), if your goal is retirement savings. If you’re not saving for retirement, then check out an online savings account or a online stock broker.
Roth IRA vs 401K Facts
401K
- Contributions are Pre-Tax
- Annual Contribution Limit is $16,500
- No Income Limits
- Withdraw Contributions at 59 ½ years-old
- Mandatory Withdrawals at 70 ½ years-old
- Participation Tied to Employer and Employer’s Choice of Funds
Roth IRA
- Contributions are After-Tax
- Annual Contribution Limit is $5,000
- Contributions Limited Based on Income
- Withdraw Contributions at Any Time Without Penalty
- No Mandatory Withdrawals
- Very Flexible
The Case for the 401K
I love the 401K. It’s the old guy on the retirement investing block. Just a bit younger than deceased grandpa pension. All kidding aside, it’s got some massive advantages. First, most people with corporate jobs have access to contribute to one. And most people get to direct their contributions to the funds of their choice.
The biggest advantage of the 401K is the tax deferral. Since the annual contribution limit is $16,500, you get to avoid paying taxes on that much in income every year. If you’re in the 25% tax bracket, that could mean >$4,000 in tax savings. High income earners (>$75,000) should be maxing out each year.
The last thing I’m going to say about the 401K is that if your employer offers any kind of 401K contribution match, please take advantage of that benefit. It’s free money for your retirement.
Check to see how your 401K ranks amongst others.
The Case for the Roth IRA
I also love the Roth IRA. It came along in the 90s as a new investment tool used to encourage people to invest in their retirement by promising no taxes in retirement. With a Roth IRA, you invest today’s after tax dollars and never pay tax again on that money or the earnings from that money. If you plan to be a high roller in retirement AND you don’t make a high salary now, then this is the account for you.
The biggest advantage I see in the Roth IRA is it’s flexibility. You can open up a Roth IRA at a number of places (unlike the 401K), you can invest in just about any type of fund or asset, and you can withdraw your contributions whenever you need them without penalty. If you want to actively trade within your Roth IRA, consider one of the best online stock brokers.
Why Not Use Both?
The great thing about comparing these two accounts is that if you can’t decide which one to use, you can legally participate in both. Just make sure you meet the income limitations of the Roth. A common strategy that people use when deciding how to allocate retirement funds is this:
1. Invest in your 401K to get your company match.
2. Invest in a Roth IRA to the max.
3. Come back to the 401K and finish maxing it out.
That’s what I would call overall tax diversification in your retirement savings plan.
So what do you think of these two different retirement savings account? Which do you have and why?
Related Posts:
{ 4 comments… read them below or add one }
This site is awesome. Love the education. I do have question or two – hope you are able to help clarify:
1. Between me and my wife, can we put 10,000 (for 2009 yr – I know the deadline was today but I am just asking) in ROTH IRA? Could we open a joint IRA account at lets say Fidelity and have 10,000 deposited or do we have to have separate accounts since one person limit is only 5,000?
2. I have 401K at work and wife does not (she has pension but she won’t qualify for another yr). I know I can put 16500 max (again assuming 2009 limits) in my 401K but I am confused between 401K, traditional and Roth. If I did put 16500 in my employer 401K, can I also put 5000 in traditional IRA and 5000 in Roth IRA? That is total 26500 per person allowed to be deposited in retirement account, correct? I do know that only 21500 is pre tax and 5000 in Roth is after tax.
3. Since my wife doesn’t have 401K at work, can she only do traditoinal and Roth totaling 10000? Is there any other way to save more? (I know she has option to get paid on 1099 basis vs W2 fm work – would that be beneficial over getting paid in W2?
Thanks a bunch guys.
In regards to the article itself, I will do exactly as the article mentions. Put in enough for 401(k) company match, then Roth IRA max, then 401(k) max.
@Josh: You may be seeing this a bit late, but…
1. Good question: I don’t know the answer to that. However, read the next responses to your questions.
2. The contribution limits are per person. So, you each get $5,000 for IRA and $16,500 for 401(k). You only get $5,000 between both a traditional and a Roth IRA. You cannot put $5,000 into each of those. Between 401(k) and IRA (either Roth or traditional), you can contribute $21,500 ($16,500 + $5,000).
3. Again, no, she cannot. She can only contribute $5,000 total into any combination of IRAs. There are TONS of ways to save more. However, if you’re looking for tax-benefited savings account, then IRA and 401(k) are your only options. You can always set up individual investment accounts, but no tax benefits.
hello we are wanting to open an roth acctt, but my husband,s job offer,s a 401 k to match at 3% which would be better. thank you art and gail zamberlin.
Hi, Gail! If you are asking which would be better, I would definitely say go for the 3% match first. Then start Roth contributions. Can you do both?