Roth IRA versus 401(K) – Key Differences

Both 401(k)s and Roth IRAs are well-known tax-advantaged retirement savings plans. However, employer contributions, investment options, and tax treatment differ. Your funds can increase in both accounts tax-free. So what are the differences? Here is a look at Roth IRA versus 401(K).

Pre-tax contributions are made to a 401(k), which means they are made before income taxes are withheld from your paycheck. Withdrawals made during retirement, however, are subject to tax at your then-applicable income tax rate. On the other hand, contributions to a Roth IRA do not result in tax benefits or deductions. However, retirement allows for tax-free withdrawals of the payments.

In an ideal world, you’d have both to save money for retirement. However, individuals should know several guidelines, income thresholds, and contribution caps before choosing which retirement account is best for them.

Differences Between Roth IRA And 401(K)


Many U.S. private-sector businesses provide 401(k)s, employer-sponsored retirement plans. A 401(k) is an employer-sponsored retirement plan named after Internal Revenue Code Section 401(k). 401(k) requires you to set aside a percentage of each paycheck for contributions. These donations are made before your salary is withheld to cover income taxes. 

Your 401(k) contributions are often taken out of your paycheck before taxes, lowering your taxable income. The funds are then deposited, allowing your investments to increase tax-deferred in the account. 

Your retirement withdrawal may be liable to taxes depending on your current tax rate. The good thing about how these operate is that your contributions are automatically deducted from your salary, making it a simple option for someone to save for retirement. 

Employees can access standard and Roth vehicles if the employer permits it. The IRS will enable employees to make 401(k) plan contributions of up to $20,500 in 2022. There is an additional catch-up payment of $6,500 for employees 50 and above.

The other benefit, which is a significant one, is that some employers will match your payments. Because employer matches are free money or a 100% return on your contributions up to that match, they provide a method for your income to increase.

401(K)S: Pros And Cons

A 401k has several benefits and drawbacks.

  • A large contribution limit
  • Possibility of an employer match
  • Using a Roth 401k may permit both pre-tax and Roth contributions (k)
  • Few available investing alternatives
  • Minimum distributions are required at 72
  • For employer contributions, a vesting time might apply.

Roth IRA

An alternative way for employees to save for retirement is through a Roth Individual Retirement Account (IRA). Anyone with a source of income can start a Roth IRA with almost any well-known brokerage house.

Contributions to a Roth IRA are made after taxes, so they do not affect your taxable income for the current year. During your working years, your assets grow tax-free, and at 59 ½ years, you can start making tax-free withdrawals. After the money is in the account, you won’t have to pay taxes again.

The fact is that not everyone can contribute to a Roth IRA as it is an essential feature. To contribute to an IRA, you must first have a source of income. Additionally, you may only contribute up to 100% of your earned income, even though the maximum contribution is $6,000 annually. 

Therefore, you can only contribute what you made if your annual income is less than $6,000 in a particular year. Another significant Roth IRA restriction is that you can only invest in a Roth IRA if your income is below a specified threshold. 

You won’t be allowed to make contributions once your income reaches $144,000 for single taxpayers and $214,000 for joint filers in 2022 without completing a backdoor Roth IRA, which entails making a $6,000 contribution to a traditional IRA, investing the money, and then converting it to a Roth IRA.

Roth IRAs: Pros And Cons

A Roth IRA has a lot of benefits and drawbacks.

  • Benefits of tax-free growth and withdrawals on investments
  • A greater selection of investing possibilities
  • No minimum distributions are necessary.
  • Limited contribution amount
  • No chance of an employer match
  • Depends on income restrictions

Which Is Better For Investing: A Roth IRA Or A 401(K)?

If you’re debating between a 401(k) and a Roth IRA, don’t because you should be doing both. If you are eligible through a 401(k) at your employment, experts concur that this should be the first account you use. Don’t forget to put in enough to qualify for the employer match first.

As previously noted, an employer match is a free money you don’t want to pass up. If you can, try to leverage the $6,000 annual maximum. If you still have leftover money, return it to your 401(k) and use the full $20,500 annual maximum. After that, turn to your Roth IRA.

What Is More Tax-Friendly? A 401(K) Or A Roth IRA?

As previously established, the tax benefits of a Roth IRA and a 401(k) differ. Most 401(k) contributions are made pre-tax, lowering your current-year tax liability by reducing your taxable income. While it is in your account, the money grows tax-free, and when you start taking withdrawals from your 401(k), you will be taxed at your regular income tax rates.

In contrast, you can contribute to a Roth IRA after paying taxes. Although there is no tax benefit in the current year, your money grows tax-free in the account. You can receive both your contributions and gains tax-free in retirement.

Taxpayers with high incomes today who anticipate having reduced incomes in retirement typically benefit more from traditional 401(k) contributions. In other words, if your tax rate is high, you can enjoy a tax credit and postpone paying that tax until your rate is lower. 

Which Tax Benefit Is Superior?

For individuals who anticipate being in a higher tax bracket in retirement, a Roth IRA is superior. You can pay your taxes now when your tax rate is lower and then take tax-free withdrawals in retirement when your tax rate is higher.

The draw of a Roth IRA for many young individuals is that they pay tax on the money now, when they may be in some of the lowest tax brackets of their lives. Unfortunately, it’s impossible to predict whether your income tax rate will increase or decrease as you age.