Roth IRA vs 401(k)? You May Not Have to Choose

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A 401(k) and a Roth IRA are the two most popular ways to save for retirement, but which account is best? It depends on several different factors, including eligibility, income, employer match, and contribution limits. In some cases, you don’t even have to choose between one type of retirement investment account or the other, because the wisest decision might be to use both.

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What’s the difference between a 401(k) and a Roth IRA?

A 401(k) is an employer-sponsored plan that is often included in the benefits package of a full-time job. If you elect to use a 401(k), you can sign up through your employer, but the account is usually managed by an investment bank like Fidelity or Vanguard. When you enroll, you can choose how much of each paycheck you’d like to contribute toward your account. Many employers will match some or all of your contributions with money of their own, so if you don’t take advantage of a 401(k), you’re literally leaving money on the table. Most 401(k) plans allow you some control over how your cash is invested — you can either use a hands-off approach and let the bank make all investment decisions, or you can play a more active role. Of course, a 401(k) is only an option if your employer offers one.

On the other hand, a Roth IRA is an individual retirement plan you can open directly with a bank or investment firm. It is not employer-sponsored, so anyone can open a Roth IRA, regardless of your employer. You also might have even more control and flexibility over the types of investments you make with a Roth IRA since you’ll be working directly with an investment firm, though many employers have taken steps to allow more flexibility with 401(k) plans as well.

The biggest difference between a Roth IRA and a 401(k) is how your savings are taxed. While contributions to a 401(k) plan are taken out of your paycheck before taxes (meaning you don’t have to pay taxes on them), the contributions you make to a Roth IRA are taxable. And while your employer might match your 401(k) contributions, you’ll be on your own when it comes to Roth IRAs. However, if you withdraw money from a 401(k) plan before you retire, you’ll face a stiff penalty fee and have to pay taxes on the cash you withdraw (you can take money out of a Roth IRA whenever you like).

Which is better: Roth IRA vs. 401(k)?

The best retirement plan for you depends on your personal financial situation. One type of retirement plan is not necessarily better than the other. A Roth IRA is usually more flexible when it comes to investment options, and you can choose any bank or investment firm you like. Since a 401(k) is an employer-sponsored plan, you have to choose from the investments that are available, and you’ll have to go with the investment firm your employer picked.

If you earn more than $137,000 as an individual tax filer (or more than $203,000 as a joint tax filer) in 2019, you aren’t eligible to contribute to a Roth IRA. In that case, a 401(k) is your only choice between these two accounts (but you could also consider a traditional IRA).

Also, remember that a 401(k) allows you to contribute $19,000 per year (as of 2019), while a Roth IRA only allows $6,000 per year (or $7,000 if you’re age 50 or older).

If your employer matches contributions and you can only afford to contribute to a single investment account, a 401(k) is more beneficial than a Roth IRA. An employer match is like getting free money, so contribute as much as you can until you’ve maxed out your employer’s match before you consider opening a Roth IRA.

Contributing to a 401(k) and a Roth IRA

Even if you have access to a 401(k), there’s no reason why you can’t contribute to both a 401(k) and a Roth IRA. Once you reach your 401(k) plan’s maximum annual contribution of $19,000, you can then deposit any additional money you’d like to invest in a Roth IRA up to a max of $6,000 per year.

Another option is to contribute to your 401(k) just up to the maximum your employer matches for the year (instead of the $19,000 limit), and then contribute the rest of the money you have to invest in a Roth IRA. That way, you aren’t leaving any free money on the table with your 401(k), but the rest of your investment dollars are a little more flexible in a Roth IRA.

The bottom line

There is no one-size-fits-all solution when it comes to evaluating a 401(k) vs. a Roth IRA. It all comes down to your personal finances, your employer, and how much money you’d like to contribute each year. In the end, a 401(k) account may be the best option to take advantage of first — assuming your employer offers one and matches some of your contributions — but after that, you might benefit from using both types of accounts.

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