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?

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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.

    1. 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?

    1. 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.

  6. Avatar Dona Bellanger says:

    great post to share keep posting

  7. Avatar Philip Taylor says:

    I’m actually going through this process for myself right now. I’ll let you know what I find out. One thing I can say is that I wouldn’t let the payroll company lead me into anything. I’d go find the best solution myself independent of their help.

  8. I am currently enrolling in my companies 401k. They match 100% up to the first 1%. Then, they match 50% on the next 5%. The total match is up to 6%, then.

    However, I am trying to find out what the legal (IRS) limit is (in %) in order to get the total allowable tax deferral. I think it is 10%, but I am not sure. Whatever it is, I want to change my contribution to that limit so that I can take advantage of the tax deferral, even if it means I don’t get the match over the 6%.

    Can you tell me 1) if this is a good strategy and 2) what that % limit is?

    Thank you.

    1. Avatar Philip Taylor says:

      Hi Steve. The limit for 2011 is $16,500. There is no % limit. It’s a total dollar amount. Divide $16,500 by the number of paychecks you get each year. Then figure out what % that number is of your gross paycheck. Set your % at that level.

  9. thats an awesome picture

  10. Avatar Philip Taylor says:

    John. Honestly, I don’t think you can go wrong either way. Many things will change between now and retirement. Just make sure she keeps contributing to something. Some considerations:

    1. The 401(k) to Rollover IRA and then converting to Roth will mean a big payout in taxes owed. Make sure you can handle the cash outlay.

    2. Moving to a Rollover IRA is usually a smart move because it typically gives you flexibility and lower costs.

    3. You could both diversify individually by having two accounts each: you could have the 401(k) and a Roth, and she could have the Rollover IRA and then start a separate Roth. Combined, you could both be contributing over $30K a year. That’d be awesome!

  11. My fiancee and I are getting married in 2011. We are 25 and our joint income is around $90k. She has a 401k left from her first job, her new job does not offer any 401k options. My contributions are at the 7% level at my employer (matching the first 4 and 1/2 a percent up to 7%) She will now have to start her own IRA or ROTH IRA. Should I have her roll the 401k from her first job into an IRA and have her start contributing to that? should I Have her roll into an IRA then A roth IRA and contribute to the roth? If I have a 401k and she has a roth I assume at retirement we would have tax diversification? HELP!

  12. @Cliff – I just did an article on the Roth IRA withdrawal rules.

    It appears as though you will be able to immediately withdraw the money. Keep in mind you will need to convert the 401K to a Traditional (rollover) IRA first, and then convert that to a Roth IRA. Also, when you make the move to the Roth, you will have to pay some taxes.

  13. I am 75 and thinking about doing a 401K to Roth conversion . my question is, when can i start taking withdrawals from the roth? do i have to wait? or can i start right away? any other limitations?

  14. I watched a tax advisor program on OPB last night and he was pushing a Roth IRA. With a Roth IRA you pay today’s tax rate. With a Traditional IRA or a 401K you will pay the tax rate when you withdraw that money. The tax advisor predicted taxes will be going up, up, up. Therefore, you’re much wiser to invest in a Roth IRA.

  15. @Cathy – That’s great that you want to start saving. No time like the present. As for which direction to take your investments, I’m of the opinion that your biggest risk is that you won’t start. So, unless there are major limits associated with your 401K choices then split your contribution across both accounts and just get going. A good tool to see how good your 401K stacks up is If you don’t like what you see, then throw more money into the Roth. But the answer isn’t a simple one. Please make sure you weigh all the factors involved and make a choice that suits you.

  16. Thank you for the article. I’m 29 and want to start saving for retirement asap. I’m hoping you can tell me if I’m on the right track here. I want to contribute 10% of my income, approx $3500, but my employer has no match on our 401k. So I should contribute it all to a Roth IRA then, right?

  17. 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?

  18. Avatar gail zamberlin says:

    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.

  19. 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.

  20. 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.

    1. To answer your 1st question: no you can’t open a joint account. I tried earlier this year and was told and IRA was only for 1 person. Hence the I = Individual. That doesn’t stop you from opening 1 for each of you though. You’d still be saving 10k/yr max; it’ll just be split between 2 accounts.

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