What Is the Difference Between a Roth IRA and 401k?

When it comes to saving up for retirement, there are often two accounts that people talk about. The Roth IRA and 401k have the same goal, but their approaches towards money have distinct differences. Learning about these distinctions can help you maximize your savings. You can even save thousands or millions, depending on your plan.


Before we get into the Roth IRA, you first have to understand what an IRA is. It’s short for an individual retirement account. Anyone who earns income can open an IRA account through their employer. Once invested in an IRA, your money goes to different financial products. These include:

  • Mutual funds
  • Exchange-traded funds (ETFs)
  • Stocks
  • Bonds

The most common IRA is the traditional IRA. The money you place in it is tax-deductible, meaning it will apply as a deduction for tax during that month. However, when you withdraw that money later on, it will get an ordinary income tax.

There is also a limitation to how much you can contribute in a year. You cannot exceed $6,000 in contribution. That number increases to $7000 when you’re at least 50 years old.

The Roth IRA

Unlike the traditional IRA, the Roth IRA isn’t tax-deductible. You’ll have to pay tax every time you add money to the IRA. The advantage of that is when you withdraw your money. Since you already paid the tax, the amount you get during withdrawal won’t incur any tax.

Many people prefer the Roth IRA to get tax out of the way and then have their money free of tax when they retire. There are also no age limits to it. You can contribute to it as long as you have eligible earned income. However, the limits to how much you can contribute to it are like that of a traditional IRA.

The main reason people choose an IRA is that your money grows without worrying about your tax. The Roth IRA also gives you the freedom to select where you invest your money.

However, some don’t like the contribution limitations of the Roth IRA. There are also income limits depending on your household situation. Your modified adjusted gross income must be less than $125,000 if you’re single. If you have joint taxes, that number increases to $198,000.

If you go beyond that number, you lose eligibility.

The 401K

A 401k is a plan offered by your employer similar to the IRA. It acts the same way as a traditional IRA, meaning that tax applies once you withdraw from your investment later on. You can choose how much you’ll contribute to the 401k each month or set a percentage.

Unlike the Roth, where you have the freedom to choose your investments, the money in the 401k goes into select mutual funds. The funds they invest in may differ depending on your plan.

One of the benefits of the 401k is that your employer can match the amount you invest. There is no requirement, but your employer may offer it. Another plus from the 401k is that the investment is under your name. Even if the company goes under, the account will transfer back to you.

The 401k has a higher contribution limit at $19,500 a year. This amount increases to $26,000 when you’re 50 and above. The money you put into it will also become a tax deduction for that year.

However, the limitation with a 401k is there are only a few options of mutual funds. A third-party administrator handles the plan and will select the funds. You also can’t leave it in the account like a Roth, and you need to begin withdrawing money during retirement to avoid penalties.

Some companies don’t offer 401k plans until you have some tenure. It will depend upon the company’s discretion.

What To Choose?

The consideration between Roth IRAs and 401k is the tax. One way to approach this is to consider the tax environment and its projection. A Roth IRA is good if the tax environment is low right now and might go up in the future. The opposite is true for the 401k.

The good news is that you can have both to maximize your contributions. You can also convert a 401k to a Roth later on if you feel that the tax rate is acceptable at the moment.

If you want to learn more about how to effectively save money, purchase our Wealtheo saving courses. They can help you build a strategy to secure your future.

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