How to Decide Between a Roth IRA and a 401(k)

The best choice for your retirement savings may come down to how you want to deal with taxes now and when you retire.

Written by Devon Delfino / March 25, 2022

Quick Bites

  • A Roth IRA lets you contribute after-tax money and take tax-free withdrawals in retirement.
  • A 401(k) is available through your employer, and contributions to the plan reduce your taxable income.
  • Roth IRAs work well for young professionals who can’t access 401(k)s, while 401(k)s can help high earners save more for retirement.
  • Some folks may be eligible to contribute to both retirement accounts, which can help you manage your taxes now and later.

When you’re saving for retirement, you’re faced with a jumble of choices. Among them are 401(k)s, offered by employers, and individual retirement accounts that you can buy directly, such as a Roth IRA.

Figuring out what to save in can be pretty confusing. But much of the decision comes down to the tax benefits of each type of account, and over the long term it can even make sense to own a combination of retirement plans.

Here’s what you should know about Roth IRAs and 401(k)s—including the tax implications of both—so that you can make an informed decision and find the choices for you. In fact, you may want to have both types of accounts, if you’re eligible, to maximize your savings.

Inside this article

  1. Roth IRA basics
  2. 401(k) basics
  3. Roth IRA vs. 401(k)

Roth IRA basics

As long as you have earned income and make less than $144,000 in 2022 as a single filer or $214,000 as a married couple filing jointly, you can open a Roth IRA at any time.[1] Unlike with a regular IRA, you can’t deduct your contributions from your income on your tax return. Instead, you fund a Roth IRA with dollars you’ve already paid taxes on. The money in your Roth IRA grows tax-free, and when it’s time to tap the account in retirement, your withdrawals are 100% tax-free as well.[2] Sounds great, right?

There are some caveats, though. There are limits to how much you can put into a Roth IRA every year. For 2022, you can contribute up to $6,000 if you’re under age 50 and $7,000 if you’re 50 or older.[3] Those limits include all the IRAs you fund within the year.[2] If you have a traditional IRA and a Roth IRA, you won’t be able to contribute more than $6,000 to both accounts. So if you want to sock away more than that each year, you’ll need to look into other ways to save.

Tip: You can open a Roth IRA through a bank, brokerage, mutual fund company or any other IRS-approved institution.[4]

Because people tend to earn more as they get older, it can make sense to trade a tax deduction now for tax-free income later in life. “A Roth IRA can be a better choice if you’re just starting to accumulate retirement savings and have a limited amount to put away,” says Certified Financial Planner Tracy L. Sherwood of Sherwood Financial Management.

In addition to tax-free income in retirement, a Roth IRA offers another future benefit, notes Sherwood: You won’t be subject to required minimum distribution rules at age 72. That means that if you don’t need income from your Roth IRA in retirement, you can leave money in the account to grow for your beneficiaries.[2]

401(k) basics

A 401(k) is a retirement plan offered by your employer.[5] The money you contribute to a 401(k) via automatic payroll deductions is pre-tax—meaning you don’t owe income taxes on those funds. The maximum amount of income from which you can deduct 401(k) contributions is $305,000 in 2022.[6]

Contributions to a 401(k) reduce your taxable income now, and the money grows tax-deferred. But when you make withdrawals from the account in retirement, you will owe income taxes on the money you take out.[5]

The amount you can contribute is quite generous: If you’re under 50, you can set aside up to $20,500 per year in 2022; if you’re over 50, you can contribute $27,000.[6]

Another benefit is that your employer may add money to your account to encourage you to save. That means your company will match your 401(k) contributions, often 50 cents per dollar you put in up to a certain percentage of your pay.[7]

Tip: If your job offers an employer match, contribute at least up to the maximum match amount. Otherwise, you’ll lose out on free money.

However, as with Roth IRAs, 401(k) plans do have potential downsides. As Sherwood points out, 401(k)s limit your investment choices to just what’s offered by your employer’s plan. And these investments could carry high fees that cut into your savings.

Still, 401(k)s are often a great option, especially if you qualify for an employer match. “A 401(k) is better for someone earning a higher income who may not be eligible to contribute to a Roth IRA and would benefit from the pre-tax deduction,” says Sherwood.

Roth IRA vs. 401(k)

Both a Roth IRA and a 401(k) can help you save for retirement. And in both cases any growth from your savings will accumulate tax-free. But, again, there are key differences between these two retirement accounts. Here’s a quick comparison:

Roth IRA401(k)
Who holds the accountYou—so you don’t need to do anything with the account when you switch jobs. Your employer—you may need to roll over your account if you change jobs.
Tax benefits Doesn’t reduce your taxable income now, but the money you take out is tax-free.Reduces your taxable income now, but you’ll pay taxes when you take out money later on.
Employer match Usually not an option, but can be for a Roth 401(k).[8] Often available up to a set percentage of your pay.
Income limits for contributionsUp to $214,000, depending on your tax filing status (married, single) in 2022.[9] Up to $305,000 in 2022.[10]
Annual contribution limits$6,000 in 2022, $7,000 if you’re 50 or older.[3] $20,500 in 2022, $27,000 if 50 or older.[6]
When you can take out money penalty-free59½ or older for earnings, but there are exceptions that let you take out earnings earlier with penalties, and you can withdraw contributions at any time.[11, 12] As early as age 55, provided you leave your company by then. Otherwise age 59½.[13]

Both of these accounts have their own pros and cons, but you don’t necessarily have to choose one of the other.

“If you’re eligible to participate in a 401(k) and fall within the income limits for a Roth IRA, you may be able to reap the rewards that both savings plans offer,” says Sherwood.

Having both account types can help you control your taxable income, both now and when you’re ready to retire. Plus, you’d be able to put away more overall, since there’s no overlap between 401(k) and Roth IRA contribution limits.

It’s also worth noting that some employers will offer a Roth 401(k), which can help you get the benefit of both accounts. Just keep in mind that any employer matching funds would be counted as income when you withdraw the money.[8]

Deciding how to approach your retirement savings plan can be complicated. To help you decide between a Roth IRA and a 401(k), Sherwood recommends looking at how much you are paying in income taxes, whether you expect that to increase over the next three to five years, and what you can do to lower your tax bill now and later.

Article Sources
  1. “Publication 590-A (2021), Contributions to Individual Retirement Arrangements (IRAs),” Internal Revenue Service, https://www.irs.gov/publications/p590a.
  2. “Roth IRAs,” Internal Revenue Service, https://www.irs.gov/retirement-plans/roth-iras.
  3. “Retirement Topics - IRA Contribution Limits,” Internal Revenue Service, https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits.
  4. “Investor Alert: Self-Directed IRAs and the Risk of Fraud,” U.S. Securities and Exchange Commisison, https://www.sec.gov/investor/alerts/sdira.html.
  5. “401(k) Plans,” Internal Revenue Service, https://www.irs.gov/retirement-plans/401k-plans.
  6. “Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits,” Internal Revenue Service, https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits.
  7. “Operating a 401(k) Plan,” Internal Revenue Service, https://www.irs.gov/retirement-plans/operating-a-401k-plan#:~:text=The%20employer%20must%20make%20at,of%20compensation%20to%20all%20participants.
  8. “Retirement Isn't Free—But Your 401(k) Match Is,” FINRA.org, https://www.finra.org/investors/insights/401k-plan-matches.
  9. “IRS announces changes to retirement plans for 2022,” Internal Revenue Service, https://www.irs.gov/newsroom/irs-announces-changes-to-retirement-plans-for-2022.
  10. “401(k) Plans - Deferrals and matching when compensation exceeds the annual limit,” Internal Revenue Service, https://www.irs.gov/retirement-plans/401k-plans-deferrals-and-matching-when-compensation-exceeds-the-annual-limit.
  11. “Retirement: Traditional IRAs and Roth IRAs,” Pennsylvania Department of Revenue, https://www.revenue.pa.gov/FormsandPublications/FormsforIndividuals/PIT/Documents/rev-636.pdf.
  12. “Roth IRA Withdrawal Rules,” Charles Schwab, https://www.schwab.com/ira/roth-ira/withdrawal-rules.
  13. “Retirement Topics - Exceptions to Tax on Early Distributions,” Internal Revenue Service, https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions.

About the Author

Devon Delfino

Devon Delfino

Devon Delfino is a writer who’s covered personal finance—including everything from student loans to budgeting to saving for retirement and beyond—for the past six years. Her financial reporting has appeared in publications like the L.A. Times, U.S. News and World Report, Teen Vogue, Masha

Full bio

Related Content