Roth IRA vs 401K: Which is Right for You?

Roth IRA vs 401K

Roth IRA vs 401K: a Classic Matchup

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.

401K Facts

  • 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 Facts

  • 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?

Avatar About Philip Taylor, CPA

Philip Taylor, aka "PT", is a CPA, blogger, podcaster, husband, and father of three. PT is also the founder and CEO of the personal finance industry conference and trade show, FinCon.

He created Part-Time Money® back in 2007 to share his advice on money, hold himself accountable (while paying off over $75k in debt), and to meet others passionate about moving toward financial independence.

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  1. Avatar Bonezbergade says

    I just turned it all over to Roth IRA so I wont have to pay taxes on it and when its maxed out I will put 3-5 percent in 401 and bye Compounding savings bond with the rest and see how it works for 5 yrs

  2. I have about $300k in my 401k.  How can I calculate the amount of tax I will have to pay if I roll it over into a  Roth IRA?

  3. Avatar Judy Shelby says

    Hi Mike.
    I am 65 years old and have just retired. I have a small 401k plan of about $43,000.00. I have to move it from where it is and don’t know what would be best. I can’t leave it where it is, because, I need to get about $10.000 out of it and roll the rest over. I am aware of the penalties, but can’t get around it.
    I just want to roll over the balance until I’m 70-1/2, when I can start drawing from it without penalty.
    I also don’t know what would be the best to put it into when I roll it over.
    Thanks,
    Judy

    • Avatar Philip Taylor says

      @Judy Shelby A Rollover IRA seems to make the most sense, but I’d definitely take the time to sit down with a financial planner to make sure. I tend to lean towards using Vanguard to handle my IRAs and using their funds within. With a 5 year time frame, you really need to focus on protecting the money. Good luck.

  4. I don’t make much money right now since I’m a full time student, but my job offers a 401k..I also have a roth ira from before when I transferred funds from my 401k to my roth ira.  Should I just stick with my roth ira?  Or enroll into my new jobs 401k?

    • Avatar Philip Taylor says

      I’m a big fan of using your work 401K. I used to try to max it out each year. If your 401K has a matching benefit then you should most definitely try to get started with that.

  5. Avatar Scott Grinas says

    401k plans are great if you maximize your contributions and the same can be said for roth ira’s although I would agree that self directed roth ira and self directed 401k products seem to be even better for small business owners.