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Roth IRA vs. 401(k): What's the Difference?

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Comparison of Roth IRA and 401(k) retirement accounts.

A comparison chart showing the differences between Roth IRAs and 401(k)s, including contribution limits, taxation, and fees.

A 401(k) and an IRA are common accounts used to invest for retirement. There are advantages to putting your money into these accounts, like tax breaks, flexibility, and the ability to save more money for retirement. However, the two types of accounts can vary significantly in terms of how they are taxed, their fees and contributions limits, and how they are used in retirement planning. This article explores the differences between Roth IRA and 401(k) accounts, and how they can be used to achieve different retirement goals.

Roth IRA and 401(k)s are both tax-advantaged retirement plans, but they have several key differences. Roth IRA are funded with after-tax money, meaning the contributions you make are not deductible from your taxable income. The money in a Roth IRA grows tax-free, and withdrawals are tax-free in retirement. 401(k)s, on the other hand, are funded with pre-tax money, meaning the contributions you make are deducted from your taxable income. The money in a 401(k) grows tax-deferred, and withdrawals are taxed in retirement.

Another important difference between Roth IRA and 401(k)s is the contribution limits. The maximum contribution limit for Roth IRA is $6,000 per year, or $7,000 if you are age 50 or older. The contribution limit for 401(k)s is much higher, at $19,500 per year, or $26,000 if you are age 50 or older. Additionally, 401(k)s may offer a “matching” feature, which allows employers to contribute money to your retirement account.

Many employers offer their employees the option of contributing to a Roth 401(k). This type of account is similar to a Roth IRA, but it is funded with pre-tax money. The money in a Roth 401(k) grows tax-free, and withdrawals are tax-free in retirement. However, the contribution limits are much higher than those of a Roth IRA, at $19,500 per year, or $26,000 if you are age 50 or older.

Previously, many advisors suggested that clients roll over Roth 401(k) accounts to a Roth IRA to avoid required minimum distributions (RMDs). RMDs are withdrawals that must be taken from retirement accounts when a certain age is reached. However, the SECURE Act, which was passed in December 2019, changed the rules for RMDs. Under the new law, RMDs are no longer required for Roth 401(k) accounts. As a result, the steady flow of retirement dollars out of 401(k) plans and into individual retirement accounts could slow. At the very least, this may give retirement savers more flexibility in deciding how to invest their retirement dollars.

Another important factor to consider when deciding between a Roth IRA and a 401(k) is the fees associated with each account. Fees can vary significantly between different types of accounts and providers. Generally, fees and service level may be better in one versus the other, Levine said, so it is important to take the time to compare fees before deciding which type of account is right for you.

Finally, it is important to understand the rules and regulations that apply to each type of account. For example, Roth IRA allow savers to withdraw their contributions at any time without paying a penalty, but earnings can only be withdrawn without a penalty after the account has been open for five years. For 401(k) accounts, there are rules governing when and how much you can withdraw from the account. It is important to understand these rules before making any major decisions about your retirement savings.

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