Should You Contribute to a Roth IRA, Traditional IRA or 401(k)?

It’s easy to get overwhelmed by the plethora of options to choose from when it comes to trying to save for retirement. What’s the difference between opening a Roth IRA or 401k? Are there benefits to having multiple retirement accounts in order to achieve your long-term retirement goals?

With the overall goal of saving money, the retirement accounts you choose and the amount you invest now will help you achieve the retirement life of your dreams.

Roth IRA vs. 401(k): What are they?

Roth IRAs and 401(k)s are both tax-advantaged retirement savings accounts that provide you the opportunity to grow your savings tax-free. Yet, Roth IRA vs. 401k have big differences in how they are handled when it comes to investment options, tax treatment, and employer contributions. 

How does a Roth IRA work?

A Roth IRA, otherwise known as a Roth individual retirement account, allows you to grow your money tax-free. You leave your money in your Roth IRA account, allowing it to grow over the years, and then when you withdraw, you don’t have to pay income tax on that money.

You can open a Roth IRA on your own through a financial institution and select which investments you’d like to focus on. 

A Roth IRA is a type of account you set up through a financial institution, like an investment firm or bank, that allows you the opportunity to grow your money over time through investments of after-taxed dollars. 

In contrast, traditional IRAs are funded with pre-tax money and, in retirement, will pay regular income taxes on those withdrawals.

How does a 401(k) work?

Typically, 401(k) plans are employer-sponsored retirement plans that are offered as part of an employer benefit plan.

With an employer-sponsored 401(k), you designate a portion of your pay to be put into the account. For each pay period, this money will be withdrawn before taxes are paid.  This is known as a pre-tax contribution. With pre-tax contributions, you pay tax at the time of withdrawal.

401(k) plans also often offer an employer-match program. An employer can choose to match the employee’s contribution up to a certain percentage. The exact terms of the match will depend on the employer, but it typically caps out at a 50% match.

If you’re self-employed, there are solo 401(k) plans as well.

Roth IRA vs. 401(k): The benefits

Now that you understand the basics of a Roth IRA and a 401(k), it’s time to break down the benefits of each so you can weigh the pros and cons to determine which (or both) is best suited for your circumstances.

Some of the key comparisons we’ll focus on are tax treatment, investment opportunities, and, if eligible, employer contributions. 

Benefits of investing in a Roth IRA

Investing in a Roth IRA can be a beneficial saving option for those looking for versatility and tax efficiency when it comes to saving for retirement. Roth IRA benefits over 401(k) benefits also include tax-free growth.  When you file your tax return each year, you don’t have to claim investment earnings on any growth within the Roth IRA. 

Roth IRA rules state if you are 59 1⁄2 years or older and you have owned your Roth IRA for the allotted amount of time, currently five years; you are eligible at any point in time for tax-free and penalty-free early withdrawals during retirement on what you’ve contributed.

Additionally, any beneficiaries who inherit your Roth IRA won’t have to pay federal income tax on their withdrawals as long as the account has been open for the allotted amount of time.

Benefits of investing in a 401(k)

If you’ve been offered a 401(k) plan through your employer, you’re probably wondering what the benefits are and whether it’s worth cutting into your take-home pay to start investing.

Employer-sponsored 401(k)s offer workers a lot of benefits, such as tax advantages where contributions are taken directly out of your paycheck before federal income tax are withheld. By making contributions with pre-tax dollars, you’re lowering your total taxable income, which potentially helps reduce your overall tax bill.

When it comes to 401(k) contributions and your taxes, you’ll also receive a tax break when you contribute as you can deduct your contributions when you file your income tax return.

401(k)s have higher contribution limits, contribution potential at an older age, and even provide great creditor protection. If you run into financial trouble, your 401(k) money is in a place that creditors cannot get access to. 

Another benefit is that an employer can choose to match the employee’s contribution, often up to a certain percentage of what you earn or contribute, providing additional savings that will not count towards your 401(k) limit.

Lastly, you get to control how much or little contributions you put toward your 401(k). Therefore the earlier you start investing, the more time your money has to grow and save for your future. 

Roth IRA vs. 401(k): Contribution limits & income thresholds

When planning for retirement, you should plan accordingly for the yearly limit restrictions employers and individuals must abide by when contributing to a retirement plan, 401(k), or IRA. 

Every plan is based on individuals’ income threshold and will specifically state the limits for contributions, but the limits will all differ depending on your type of plan.

Contribution limits for Roth IRAs

Let’s start with the basics. Who can contribute to a Roth IRA? With no age limit or threshold, anyone can contribute to a Roth IRA as long as their earned income is greater than the minimum investment required to open the account, and the income constitutes as qualified earned income per the IRS guidelines.

Now, let’s break down contribution limits for Roth IRAs. For the year 2024, the maximum annual contribution to a Roth IRA is:

• $7,000 if you are under age 50
• $8,000 if you are age 50 or older

It’s worth noting up front that the annual contribution limits for a Roth IRA are much smaller than for a 401(k).

Income thresholds for Roth IRAs

Income thresholds for Roth IRAs determine the contributions you can make based on how much you earn within the year. The income limits change every year, and the contribution amount allowed can be reduced or phased out until it is eliminated, depending on your income and filing status.

For 2024, Roth IRA income thresholds based on MAGI are as follows:

• Single, married filing separately, or head of household filing status:
  • Less than $146,000
    • Maximum annual contributions $7,000 ($8.000 if over the age of 50)
  • Between $146,000 and less than $161,000
    • Maximum annual contributions: reduced or phased out
  • $161,000 or more
    • No contributions allowed to your Roth IRA account

• Married couples filing jointly or qualified widower filing status:
  • Less than $230,000
    • Maximum annual contributions $7,000 ($8,000 if over the age of 50)
  • Between $230,000 and less than $240,000
    • Maximum annual contributions: reduced or phased out
  • $240,000 or more
    • No contributions allowed to your Roth IRA account

Contribution limits for 401(k) accounts

Comparatively, 401(k)s have a much higher contribution limit than Roth IRAs.

For the year 2024, individual contribution limits are:

• $23,000, if you’re under age 50
• $30,500, including the allowance for a catch-up contribution of an extra $7,500 if you are 50 years or older

2024 combined employer contribution limits:

• $69,000 in total contributions, including employer match, if you’re under age 50
• $76,500 if you’re 50 or older, including catch-up contributions
• Or 100% of your salary (whichever comes first)

If you’ve recently started a 401(k), it’s important to keep your contributions within your financial comfort level. Over time, as you earn more, you can continue to increase your contributions up to the limit.

Income thresholds for 401(k) accounts

There is no income limit for contributing to your 401(k).

How to maximize both accounts to plan for retirement

You can optimize your savings for retirement by learning how to strategically invest. If you’re financially able to, it may be worthwhile to invest in both a Roth IRA and a 401(k) plan. That way, when retirement comes around, you’re not paying income tax on all of your withdrawals. This will also let you diversify your investments.

When considering your retirement options, it’s important to note that there are many differences between a traditional IRA vs. a Roth IRA as well as traditional IRA vs. a 401(k). Learn more about your investment opportunities as you plan for your future.

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