401(k)s and Roth IRAs are popular tax-advantaged retirement savings accounts that differ in tax treatment, investment options, and employer contributions. In a perfect scenario you’d have both in which to put aside funds for retirement. However, if you have to decide between the two, here are some ways these accounts differ.

Key Takeaways

  • If your employer offers a 401(k) matching program, it’s a great opportunity to save even more retirement dollars.
  • A Roth IRA doesn’t offer the same type of benefit, as it’s an individually owned account.
  • If you believe you’re going to be in a higher income bracket in retirement, a Roth IRA may make the most sense.
  • Having both a 401(k) and a Roth IRA (provided you can afford to fund both) presents the most opportunities for a well-funded retirement.

What Is a 401(k) Plan?

Named after section 401(k) of the Internal Revenue Code, a 401(k) is an employer-sponsored retirement plan. To contribute to a 401(k), you designate a portion of each paycheck to divert into the plan. These contributions occur before income taxes are deducted from your paycheck.

The investment options among different 401(k) plans can vary tremendously, depending on the plan provider. Nevertheless, no matter which fund (or funds) you choose, any investment gains realized within the plan are not taxed by the Internal Revenue Service (IRS).

Investment gains you make within your 401(k) are never taxed by the IRS.

401(k) Contribution Limits

401(k)s have much higher contribution limits than Roth IRAs. For 2019 the 401(k) contribution limit is:

  • $19,000 if you’re under age 50
  • $25,000 if you’re age 50 or older

401(k) Employer Match

401(k) plans are most beneficial when your employer offers a match, contributing additional money to your 401(k) account. The match is usually a percentage of your contribution, up to a certain percentage of your salary. For example, your employer may match 50% of your contributions, up to 6% of your salary. The employer match doesn’t count toward your contribution limit, but the IRS does cap the total amount that can go into your 401(k) each year (your contributions plus the match).

  • $56,000 if you’re under age 50
  • $62,000 if you’re age 50 or older
  • 100% of your salary (if it’s less than the dollar limits)

401(k) Taxes

You get a tax break when you contribute to a 401(k). That's because you can deduct your contributions when you file your income tax return. This reduces your taxable income, which saves you money.

You’ll pay taxes after you reach retirement age and begin to make withdrawals from the plan. These distributions, as they are known, are subject to income taxes at your then-current tax rate. If you think your income will be higher when you retire, you may want to plan ahead, as all income from your distributions will be taxed.

401(k) Required Minimum Distributions

If you have a 401(k), you have to start taking required minimum distributions (RMDs) by April 1 of the year following the year you turn 70½ or the year you retire, whichever is later. Here’s a quick look at the pros and cons of 401(k) plans.

Pros

  • Employer match

  • Higher contribution limits

  • Maintained by employer

Cons

  • Fewer investment options

  • Required minimum distributions

  • Higher fees

What Is a Roth IRA?

A variation of traditional individual retirement accounts (IRAs), a Roth IRA is set up directly between an individual and an investment firm. Your employer is not involved.

As you set up and control the account, your investment choices aren’t limited to what the plan provider offers. This gives IRA holders a greater degree of investment freedom than employees have with 401(k) plans, even though the fees charged by those providers are typically higher.

In contrast to the 401(k), after-tax money is used to fund a Roth IRA. As a result, no income taxes are levied on withdrawals during retirement. While in the account, any investment gains are untaxed.

Roth IRA Contribution Limits

The contribution limits are much smaller with Roth IRA accounts. For 2019 the maximum annual contribution for a Roth IRA is:

  • $6,000 if you’re under age 50
  • $7,000 if you’re age 50 or older

Roth IRA Income Limits

For 2019 you can make a full contribution if your income is less than $122,000 for individuals and $193,000 if you're married filing jointly. If your income is between $122,000 and $137,000 for individuals and $193,000 and $203,000 for those married filing jointly, you can make a reduced contribution. If you earn more than $137,000 per year—or $203,000 for those married filing jointly—you can’t contribute to a Roth IRA.

Roth IRA Withdrawals

You can withdraw your Roth IRA contributions at any time or any age with no tax or penalty. Withdrawals on earnings, however, could be subject to income taxes and a 10% penalty, depending on your age and how long you’ve had the account.

In general, you can avoid taxes and the penalty if your account is at least five years old and the withdrawal is:

If you don’t meet those guidelines, you may be able to avoid the penalty (but not the tax) if a qualified exception applies.

Unlike 401(k)s, Roth IRAs have no RMDs during your lifetime. If you don’t need the money in retirement, you can leave it in the account, where it can continue to grow tax free for your beneficiaries.

Here’s a rundown of the pros and cons of Roth IRAs.

Pros

  • Withdrawals are tax free in retirement

  • More investment choices

  • No RMDs during your lifetime

Cons

  • Lower contribution limits

  • Income limits can prevent you from contributing

  • No employer match

The Bottom Line

Here’s a rundown of the differences between 401(k)s and Roth IRAs.

401(k)s vs. Roth IRAs
Feature 401(k) Roth IRA
Upfront tax break Yes. Contributions are deductible. No
Withdrawals Taxed as ordinary income Tax free
Contribution Limits $19,000, or $25,000 if you’re age 50 or over $6,000, or $7,000 if you’re age 50 or over
Income Limits No Yes. At higher incomes contributions are reduced or eliminated.
Employer Match Yes. There’s a $56,000 ($62,000 for age 50 or over) limit on combined employer/employee contributions. No
Automatic Payroll Deduction Yes No
Earliest age to withdraw funds without penalty 59½ Withdraw contributions at any time, earnings at 59½
RMDs Yes. RMDs must start by April 1 following the later of the year you reach age 70½ or the year you retire. Not during the owner’s lifetime
Average Fees High Low
Investment choices Few Many
Maintained By Employer Self

In many cases a Roth IRA can be a better choice than a 401(k) retirement plan, as it offers a flexible investment vehicle with greater tax benefits—especially if you think you’ll be in a higher tax bracket later on. However, if your income is too high to contribute to a Roth, your employer offers a match, and you want to stash more money each year, a 401(k) is hard to beat.

A good strategy (if you can manage it) is to have both a 401(k) and a Roth IRA. Invest in your 401(k) up to the matching limit, then fund a Roth up to the contribution limit. After that, any leftover funds can go toward your 401(k)’s contribution limit. 

Still, everyone’s financial situation is different, so it pays to do your homework before making any decisions. When in doubt, speak with a qualified financial planner who can answer any questions and help you make the right choice for your situation.