401(k) vs. Roth IRA: Which Retirement Account is Best for You? - NerdWallet

401(k) vs. Roth IRA: Which Retirement Account is Best for You?

401(k) vs. Roth IRA: Which Retirement Account is Best for You?

You’ve probably heard the praises of the Roth IRA, which gets a lot of love for good reason: It offers tax-free growth, which means you’ll never pay taxes on the account’s investment earnings.

Roth IRAs are so lucrative, in fact, that it can be tempting to forgo other options, like your company’s 401(k), when planning for retirement.

But you can — and in most cases, should — contribute to both a 401(k) and a Roth IRA. You just need to prioritize those contributions wisely. Here’s how to do that:

Roth IRAs have contribution and eligibility limits

The IRS isn’t offering up the tax-favorability of the Roth IRA to just anyone — these accounts come with strict eligibility rules and contribution limits.

The contribution limit in 2015 and 2016 is $5,500 per year. Savers who are age 50 or older get an additional catch-up contribution of $1,000. (If you have both a Roth and a traditional IRA, note that it’s a combined limit — your contributions to both can only add up to $5,500.)

Also, for 2015, you cannot contribute that full amount to a Roth IRA if you are married filing jointly and your modified adjusted gross income exceeds $183,000; for single filers, that income limit is $116,000. In 2016, those limits will be adjusted upward slightly, to $184,000 for joint filers and $117,000 for singles. Incomes above those limits can contribute lesser amounts until eligibility ends completely.

If you’re not eligible for a Roth, consider combining your 401(k) with a traditional IRA.

A 401(k) with matching dollars comes first

Most people who have a 401(k) also receive matching dollars from their employer — 94% of plan sponsors offer a matching or profit-sharing contribution, according to a recent Deloitte report.

So if you have a 401(k), contributing enough to get that employer match is priority one. If you don’t do that, you’re walking away from free money.

Those dollars can add huge weight to your retirement account: Someone who earns $50,000 and contributes 6% annually to a 401(k) will have a balance of over $600,000 after 35 years, factoring in salary increases and a 7% return. Add in an employer match of 50% — relatively standard these days — and that balance jumps by more than $300,000.

Then start contributions to a Roth IRA

The employer match is what redeems most 401(k) plans, which tend to have high fees and limited investment options.

Because of those drawbacks, if your 401(k) doesn’t offer matching dollars — or if you’ve already contributed enough to grab them for the year — you should move your focus to a Roth IRA.

Unlike a 401(k), you’ll contribute after-tax dollars to a Roth, which means there is no immediate tax break on contributions. That’s easily offset by the tax-free growth of your investment earnings. You can pull money out of your Roth in retirement without owing a cent to the IRS.

A Roth also gives you a bit more access to your money. Both 401(k)s and IRAs should be used for retirement, and the money contributed should be considered long-term savings. That said, you’re allowed to pull your contributions out of a Roth at anytime.

The earnings on those contributions can be tapped, too, but only for limited qualified early distributions; otherwise, earnings have to stay in the account until age 59 ½ if you want to avoid taxes and penalties.

A 401(k) makes it more difficult to get your money, though there are early withdrawal exceptions for that account, too, as well as loan options.

Want to keep saving? Go back to the 401(k)

Depending on your retirement needs, a 401(k) with a match and the smaller contribution limit of a Roth IRA may still not be enough to build a decent nest egg.

To continue saving for retirement once you’ve maxed out your Roth IRA for the year, restart contributions to your 401(k). It has a much higher annual contribution limit — $18,000 in 2015 and 2016, with catch-up contributions of $6,000 for those age 50 and older.

Although you’ll no longer get matching dollars, a 401(k) is still a tax-advantaged way to save for retirement.

Don’t have a Roth IRA? Here are some of NerdWallet’s top picks

Best Roth IRA Providers Overall

TD Ameritrade logo
5.0_stars
  • Mutual funds: Over 2,000 commission-free mutual funds
  • ETFs: Over 100 commission-free ETFs
  • Customer service: 126 local branches; phone support 24/7; email support
  • Account fees: $75 account transfer fee, waived for clients who either average five or more trades per month in their account or have a total account value of $100,000 or more
  • Account minimum: $0
  • Stock commissions: $9.99
  • Current promotion: Roll over a 401(k) or open an IRA with $3,000 or more and get commission-free trading for 60 days, plus a cash bonus for larger amounts. (Bonus is $600 on $250,000+; $300 on $100,000 to $249,999; and $100 on $25,000 to $99,999.)
  • Learn more about TD Ameritrade
Get started

5.0_stars
  • Mutual funds: Over 1,300 commission-free mutual funds
  • ETFs: Over 100 commission-free ETFs
  • Customer service: 30 local branches; 24-hour phone support weekdays; email support and live chat
  • Account fees: $60 outgoing transfer fee
  • Account minimum: $0
  • Stock commissions: $6.99 to $9.99
  • Current promotion: 60 days of free trades (up to 500) on deposits of $10,000 or more; plus bonuses on deposits of $25,000 or more. (Bonus is $2,500 on $1,000,000+; $1,200 on $500,000 to $999,999; $600 on $250,000 to $499,999; $300 on $100,000 to $249,999; and $200 on $25,000 to $99,999.)
  • Learn more about E*Trade
Get started

Best Roth IRA Providers for Beginners


5.0_stars
  • Mutual funds: Over 1,300 commission-free mutual funds
  • ETFs: Over 100 commission-free ETFs
  • Customer service: 30 local branches; 24-hour phone support weekdays; email support and live chat
  • Account fees: $60 for outgoing transfer or to close account
  • Account minimum: $0
  • Stock commissions: $6.99 to $9.99
  • Current promotion: 60 days of free trades (up to 500) on deposits of $10,000 or more; plus bonuses on deposits of $25,000 or more. (Bonus is $2,500 on $1,000,000+, $1,200 on $500,000 – $999,999, $600 on $250,000 – $499,999, $300 on $100,000 – $249,999 and $200 on $25,000 – $99,999.)
  • Learn more about Etrade
Get started
5.0_stars
  • Mutual funds: 2,500 commission-free mutual funds
  • ETFs: No commission-free ETFs. $7 per trade.
  • Customer service: Over 500 local branches; phone support weekdays 6 a.m. to 1 a.m. ET; Saturday and Sunday 9 a.m. to 7 p.m. ET; email support and live chat
  • Account fees: $75 for outgoing transfer or to close account
  • Account minimum: $0
  • Stock commissions: $7
  • Current promotion: Get up to a $2,000 cash bonus if you open a new account or fund an existing account. (Bonus is $2,000 on deposits of $1,000,000+, $1,000 on $500,000 – $999,999, $600 on $200,000 – $499,999, $300 on $100,000 – $199,999 and $100 on $50,000 – $99,999.)
  • Learn more about Scottrade
Get started

Best Roth IRA Providers for Hands-off Investors

Betterment logo
5.0_stars
  • Mutual funds: Betterment does not invest in mutual funds.
  • ETFs: Betterment invests in ETFs with expense ratio ranging from 0.9% to 0.17%. No commission to purchase.
  • Customer service: Phone support weekdays 9 a.m. to 8 p.m. ET, and Saturday and Sunday 11 a.m. to 6 p.m. ET; live chat and email support
  • Account fees: Three tiers: under $10,000, 0.35% annual advisory fee with minimum of $100/month auto deposit or $3 a month without auto deposit; $10,000 to $100,000, 0.25% annual advisory fee; $100,000+, 0.15% annual advisory fee.
  • Account minimum: $0
  • Stock commissions: Betterment does not trade stocks.
  • Current promotion: Get one month free if you sign up now.
  • Learn more about Betterment
Get started

4.0_stars
  • Mutual funds: Wealthfront does not invest in mutual funds.
  • ETFs: Wealthfront invests in ETFs with an average expense ratio of 0.12%. No commission to purchase.
  • Customer service: Phone support weekdays 8 a.m. to 5 p.m. PT;  email support
  • Account fees: First $10,000 managed free, then 0.25% annual advisory fee
  • Account minimum: $500
  • Stock commissions: Wealthfront does not trade stocks.
  • Learn more about Wealthfront
Get started

See our full list of best Roth IRA providers >

 

Arielle O’Shea is a staff writer at NerdWallet, a personal finance website. Email: aoshea@nerdwallet.com. Twitter: @arioshea.


Image via iStock.

This post was updated Nov. 12, 2015.

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  • Glenn

    The article says, “…It’s always an option to utilize both…”
    Since the contribution limits for 2013 are $17,500 for the 401k and $5,500 for the ROTH, what are the limits if I want to contribute the max permissible to both? Surely one is not permitted to contribute the full $17,500 to the 401k AND the full $5,500 to the ROTH during the same year. If I contribute $5,500 to the ROTH, must I reduce my 401k contribution by that $5,500 to $12,000?

  • Chris Whelan

    Learn why simply relying on a 401k could greatly impact your retirement plan,

  • Jerry Malinab

    wow…..

  • Clint Woo

    So i need some clarification on the advantage of 401k where the article said “You believe that your income (and, therefore, income tax rate) will be lower in retirement than it is now…..” What does this mean exactly?

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  • http://www.coralseamercantile.com.au Coral Mercintile

    A Roth is risky for several reasons. Your tax bracket in late life will probably be lower, since you needs will probably be lower (no more house payments, for example). The fact that you lose money up front to taxes means your compound interest is far less too. Not to mention the fact that there’s no guarantee that a Roth won’t be taxed later under different rules. For many it just doesn’t make sense unless your capping out your normal 401K or are getting good matching on it.

  • http://www.fifocapitalcoralsea.com.au/ fifocoralsea

    I enjoyed reading this posting. It’s comforting to know that there are people who are actively planning and saving for their golden years. I have been socking money away for myself, wife and three boys.

  • Mandeep

    very informative. I have been looking for this answer for a long time. What is the difference between regular and Roth IRA?