Roth IRA vs 401(k): Which is right for you? 

What are the differences between a Roth IRA and a 401(k)?

Navigating the world of retirement savings can sometimes feel like deciphering a secret code. There are a large number of different options, limitations, and acronyms to learn. Two of the most popular and powerful tools for retirement savings are the 401(k) and the Roth IRA. Both types of accounts are designed for long-term savings but have distinct and almost opposite advantages. Paired with some eligibility restrictions for Roth IRAs, it’s often difficult to decide which would offer you the most benefits in your plan. You don’t have to make that decision alone, however. A qualified financial professional can help you make a plan that best meets your needs. Let’s cover some of the main differences between the two now:

Contributions

When it comes to contributions, 401(k)s generally allow for much higher annual contributions and often come with a valuable employer matching, which is essentially free money. If your employer offers a match, you should absolutely be taking full advantage of it before exploring other options. With traditional 401(k)s, contributions are pre-tax, which reduces your current taxable income. For most people, this is beneficial, because you are generally in a higher tax bracket during your earning years than during retirement.

In contrast, Roth IRAs have significantly lower contribution limits and receive no employer match. They do provide other benefits, however. Since all contributions are made with after-tax dollars, you have greater access to that money should you need it for other expenses, and qualified withdrawals in retirement are tax-free.

Investment options

Investment options in a typical 401(k) are usually limited to around 30–50 funds, depending on your employer and the plan administrator. For most, that provides plenty of options. You can choose funds that target your ideal retirement date, funds that focus on certain business sectors, or index funds, which generally offer lower fees.

Roth IRAs are accounts that you set up individually, and thus can hold virtually any publicly-traded security. That includes stocks, bonds, ETFs (exchange-traded funds), mutual funds, and more. This allows for more tailored control for active investors.

Growth

Both the 401(k) and Roth IRA offer significant tax advantages on investment growth. A traditional 401(k) provides tax-deferred growth, meaning your investments compound without being taxed annually, and taxes are only paid upon withdrawal in retirement. With Roth IRAs, since contributions are made with money that has already been taxed, your growth is completely tax-free.

Withdrawals

Accessing funds in retirement is where the tax benefits of each account truly manifest. For a traditional 401(k), all withdrawals made in retirement (typically after age 59½) are taxed as ordinary income, as the contributions were initially tax-deductible. Early withdrawals from a 401(k) before age 59½ are generally subject to ordinary income tax and a 10% penalty, though some plans may allow loans or have specific hardship exceptions.

Roth IRAs have different rules. You can always withdraw your contributions whenever you want. There are no penalties or taxes. However, there are rules on withdrawing earnings similar to 401(k)s. Once you are age 59½ and have had the account for at least five years, any withdrawals are completely tax-free and penalty-free.

A final important note is that traditional 401(k)s also have required minimum distributions (RMDs), meaning account holders must start withdrawing funds once they reach a certain age (currently 73 for most), ensuring the account cannot grow indefinitely and the government eventually collects its tax revenue. Roth IRAs have no requirements and can be allowed to grow longer.

How to choose: Roth IRA vs 401(k)

For most, a 401(k) is generally the first option when it comes to retirement savings, particularly if your employer offers matching contributions. There are limited reasons you may want to choose a Roth IRA over a 401(k). However, both are often used together in a comprehensive savings plan. Here is a rundown of many of the points we’ve already covered:

Do you qualify for a Roth IRA?

When making a decision between the two, you must first determine if you even qualify for a Roth IRA. These accounts are restricted from high earners although there are some potential options like a backdoor Roth IRA. The income limits change yearly.

See Roth IRA eligibility and income limits

Can you have both a Roth IRA and a 401(k)?

Yes, you can. Contribution limits for 401(k)s and Roth IRAs are separate, so you can use both in your retirement savings plan. For many, using both is an optimal retirement savings strategy because it allows you to leverage the unique benefits of each account, diversifying your future tax liability.

Can you transfer a 401(k) into a Roth IRA?

Yes, it is possible to transfer funds from a traditional 401(k) into a Roth IRA, a process typically referred to as a Roth conversion or Roth rollover. The crucial point is that this conversion is a taxable event: Since the funds in a traditional 401(k) were contributed pre-tax, they will be subject to ordinary income tax in the year of the conversion.

Should I max out my 401(k) or Roth IRA first?

That will depend on your goals. However, most financial experts will recommend prioritizing contributions to your 401(k) at least enough to capture your full employer match. After that you may want to continue taking advantage of pre-tax contributions in your 401(k) or max out your Roth IRA for the tax-free benefits in retirement. Either way, consulting with a qualified financial professional can help you set reachable goals to meet and exceed your retirement dreams.

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Neither New York Life Insurance Company nor its Agents offer personal tax advice. Contact your tax adviser to find out how the general information in the article may or may not apply to your specific situation.