Both Roth IRAs and 401(k) plans are popular retirement savings vehicles, but they differ in several key ways:
Roth IRA:
- Tax Treatment: Contributions are made with after-tax dollars, so qualified withdrawals (after age 59½ and the account has been open for at least five years) are tax-free.
- Contribution Limits: For 2023, the contribution limit is $6,500 ($7,500 if you’re 50 or older).
- Income Limits: Higher income earners may have reduced contribution limits or be ineligible to contribute directly.
- Withdrawal Flexibility: Contributions (not earnings) can be withdrawn at any time without penalty.
- Investment Options: Typically offer a broader range of investment choices compared to 401(k) plans.
401(k):
- Tax Treatment: Contributions are made with pre-tax dollars, reducing taxable income in the year they are made. Withdrawals are taxed as ordinary income.
- Contribution Limits: For 2023, the contribution limit is $22,500 ($30,000 if you’re 50 or older).
- Employer Contributions: Many employers offer matching contributions, which can significantly enhance your retirement savings.
- Withdrawal Rules: Generally, withdrawals before age 59½ incur a penalty, and there are specific rules for taking loans or hardship withdrawals.
- Investment Options: Limited to the investments offered by the employer’s plan (usually a selection of mutual funds).
When to Choose Each:
- Choose a Roth IRA if: You expect to be in a higher tax bracket in retirement, want tax-free withdrawals, and value flexibility in accessing your contributions.
- Choose a 401(k) if: You want to take advantage of the higher contribution limits and any employer matching contributions.
Consider your individual financial situation, retirement goals, and tax implications when choosing between the two. It may also be beneficial to consult a financial advisor for personalized advice.