Roth IRA vs. 401(k): 12 Key Differences

You have a lot of choices to make when it comes to your retirement savings. One of the most important is where you're going to keep your money until you're ready to start withdrawing it.

There are many options out there, but two of the most popular are the Roth IRA and the 401(k). Here's a closer look at 12 key differences between them to help you decide which one is best for you.

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Contributions to traditional 401(k)s reduce your taxable income for the year, but you pay taxes on your withdrawals later. This is usually the better way to go if you believe you're in a higher tax bracket now than you'll be in once you retire.

Roth IRA contributions, on the other hand, don't give you a tax break this year. But you get tax-free withdrawals in retirement. This is usually a smarter option for those who believe they'll be in the same or a higher tax bracket once they retire.

You can only contribute to a 401(k) if your employer offers one. Some companies further restrict who's eligible by requiring employees to work for the company for a certain length of time before they can participate in the 401(k) plan.

Roth IRAs don't have these restrictions. Most people can contribute as long as they earn enough money during the year to cover their contributions or are married to someone who has earned enough to cover the couple's combined contributions. But some high earners can't contribute to a Roth IRA directly. They must use a backdoor Roth IRA instead.

Adults under 50 may contribute up to $20,500 to a 401(k) in 2022, while they can contribute only up to $6,000 to a Roth IRA. These limits can change from year to year, but 401(k) limits are always significantly higher than Roth IRA limits.

Those who want to set aside large sums for retirement often have to use a Roth IRA in conjunction with another retirement account in order to avoid government penalties for overcontributions.

ALSO READ: How Much Should You Contribute to Your Roth IRA in 2022?

Adults 50 and older are allowed to make catch-up contributions to their retirement accounts. These are extra contributions above and beyond what adults under 50 can make.

In 2022, workers 50 and older can contribute an extra $6,500 to their 401(k)s and $1,000 to their Roth IRAs, bringing their contribution limits to $27,000 and $7,000, respectively.

You fund your 401(k) through a payroll deduction. You tell your employer how much you'd like to contribute, and it automatically withholds this amount from your paycheck and places it into your 401(k). If you'd like to contribute more, you must increase your payroll deduction. You can't just make one-off contributions.

Roth IRAs do allow one-off contributions, and you may be able to schedule automatic contributions as well. If your IRA provider enables you to link a bank account, you can schedule regular contributions that are similar to a 401(k) payroll deduction.

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All 401(k) contributions must be made by Dec. 31 of a particular year. For example, if you want to make a contribution for 2022, you must do so by Dec. 31, 2022.

That's not the case with Roth IRAs. You can make a Roth IRA contribution at any time until the tax deadline -- usually April 15 of the following year. So you can still make a Roth IRA contribution for 2021, if you'd like. However, you must be careful to designate it as a prior-year contribution if you do this.

Some employers who offer 401(k)s match some of their employees' contributions. How much employees get depends on how much they contribute, their salary, and the company's matching formula. Check with your company's HR department if you're unsure how its matching system works.

Unfortunately, there's no way to get a match with a Roth IRA. These accounts are entirely self-funded.

ALSO READ: How Much Is Your 401(k) Match Really Worth?

With a 401(k), you're usually limited to a few mutual funds your employer preselects for you. If you don't like what's offered, you can request that your employer add more options. But an employer is not required to do so.

A Roth IRA gives you virtually unlimited investment options. You can invest directly in stocks, bonds, mutual funds, exchange-traded funds, and more.

Typically, 401(k)s have higher fees than Roth IRAs. This is especially true for smaller companies that don't have as many employees to spread the administrative costs among. There isn't much you can do to avoid most 401(k) fees, though you can try to look for low-cost investments whenever possible.

Roth IRAs usually have few fees, and since you can choose from a wider variety of investments, you have a lot more control over what you pay in investment fees. This can help you hold onto more of your own money.

Typically, you'll face penalties if you withdraw money from any retirement account before 59 1/2. But the rules are stricter for 401(k)s. There are exceptions to the early withdrawal penalty for certain withdrawals, like large medical expenses or a first-home purchase. But there's certain criteria you must fulfill in order to make these withdrawals penalty free.

The rules are more lenient for Roth IRAs. You can withdraw your Roth IRA contributions at any time without penalty because you've already paid taxes on them. But if you try to withdraw your earnings under 59 1/2, you could owe taxes and penalties.

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Some 401(k)s allow participants to take out loans. This enables them to access some of the money in their 401(k) without dealing with the penalties of an early withdrawal. But not all employers allow this, and you could still face penalties if you fail to keep up with the loan payments.

Roth IRAs don't permit any type of loan. If you plan to take money out of one of these accounts, it's automatically considered a withdrawal.

ALSO READ: More Than 1/3 of Workers Have Made This Big Retirement Savings Mistake

Beginning in the year you turn 72 (or in the year you turn 70 1/2 if you reached this age before 2020), you must begin taking required minimum distributions (RMDs) from your 401(k). This is a mandatory minimum amount you must withdraw each year. It varies depending on your age and your 401(k) balance. You may not always want to take the money out, but skipping it isn't an option. You'll pay a 50% penalty on the amount you should have withdrawn.

Roth IRAs are the only retirement account that doesn't have RMDs, so it's a great option for those who want to leave their money in their retirement account until they feel they're ready to withdraw it.

The fact that there are so many differences between the Roth IRA and the 401(k) means the accounts actually complement each other well. In fact, if you have access to both, you may decide to open one of each.

You can start by contributing to the 401(k) until you've claimed your full match. Then, you can switch over to the Roth IRA to take advantage of its lower fees and greater investment selection. Once you've maxed that out, you can switch back to your 401(k) for the rest of the year.

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