Should You Choose a Roth IRA Over a 401(k) for Retirement Savings?

If you're a new investor, you have several decisions to make. For example, you must determine where to invest. Ideally, you want an investment vehicle that allows your money to grow steadily over time. But is that a Roth IRA or a 401(k)? Here, we'll compare the two and help you determine which one best meets your needs.

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The best features of a Roth IRA

Each retirement plan has its own list of advantages. Here's what a Roth IRA has going for it.

• Tax-free withdrawals: With a Roth IRA, you make all contributions with after-tax dollars (in other words, on money you've already paid taxes on). Because a Roth is funded with after-tax dollars, you don't have to pay taxes on the money again when you make withdrawals in retirement. Not having to pay taxes when you're on a fixed budget is a real perk.
• Flexibility: While you would have to pay a penalty for withdrawing contributions (not earnings) from most retirement accounts before a certain age, the same is not true with a Roth IRA. You can withdraw contributions at any time without penalty.
• Investment options: When comparing the two, Roth IRAs typically offer a wider range of investment options than most employer-sponsored plans, such as 401(k)s.
• No required minimum distributions (RMDs): Unlike other types of retirement plans, Roth IRAs don't require you to take distributions. You can make withdrawals as needed. If you prefer, you can allow your savings to remain in the account and grow tax-free for even longer.

The best features of a 401(k)

• You can save more: 401(k) plans generally allow for higher annual contributions than Roth IRAs, allowing you to build your nest egg at a faster clip.
• Employer matching: Many employers offer to match a portion of your contribution each month, a move that can dramatically boost your savings.
• Lower taxes: Most 401(k) contributions are made with pre-tax dollars, meaning your contributions are deducted from your annual adjusted gross income (AGI). The ability to avoid taxes during your prime earning years is an advantage if you expect to earn more while you're working than in retirement.
• Automatic deductions: The fact that contributions are deducted directly from your paycheck makes it easier to save consistently.

The less attractive side of Roth IRAs

Few financial products can be called perfect. Here are some disadvantages associated with Roth IRAs.

• Contribution limits: You can contribute much less to a Roth IRA annually than to a 401(k). Let's say you're in your 40s and have an AGI under $150,000 (if you're single) or an AGI under $236,000 (if you're married, filing jointly). The most you can contribute to a Roth IRA this year is $7,000. If you are over 50, you can make an additional catch-up contribution of $1,000, for a total contribution of $8,000.
  
  By contrast, the 401(k) contribution limit for 2025 is $23,500. If you're aged 50 to 59 or 64 or older, you can pitch in an additional $7,500 in catch-up contributions. And beginning this year, if you're between 60 and 73, your catch-up contribution can be as much as $11,250. In short, a 401(k) allows you to contribute anywhere from $23,500 to $34,750, depending on your age.
• Income limits: If you're a high earner, you may be ineligible to contribute to a Roth IRA.
• Must wait for tax benefits: Since you're paying taxes on the funds before they're contributed, you don't receive an immediate tax benefit with a Roth IRA.

The less attractive side of 401(k)s

Again, it's tough to be perfect. Here's the downside of 401(k)s.

• Limited investment options: 401(k)s typically offer a limited selection of investment options compared to IRAs or brokerage accounts. Limited investment options mean less ability to diversify your portfolio.
• Sneaky fees and expenses: 401(k)s come with investment management fees and administrative costs that can eat into your returns over time. Worse, if you feel rushed to sign up for an employer-sponsored 401(k), you may not take the time needed to familiarize yourself with how much you're paying in fees and expenses.
• Withdrawal restrictions: It can be a challenge to access funds from a 401(k) in the event of an emergency. That's because withdrawals made before age 59 1/2 typically incur a 10% penalty in addition to income taxes at your ordinary tax rate.
• RMDs: Beginning at age 73 (or 75 if you were born in 1960 or later), you must begin taking RMDs from your 401(k), even if you don't need the funds to cover bills. It's at that time that you'll owe taxes on the amount withdrawn. While it's nice to get a tax break while contributing to a 401(k), the taxman eventually wants his piece of the pie.

The good news is this: Choosing between a Roth IRA and a 401(k) is not an all-or-nothing scenario. There's no rule saying you can't invest in both, and that may be precisely what you decide to do. In the meantime, how nice is it to know you have options?

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