Both accounts offer perks worth considering.
Understanding 401(k): How it works and why it matters
What is the 401(k) plan? Key benefits and ways to maximize savings.
For many of us, retirement may seem far apart. However, if you ask people who have already retired, many of them will tell you how quickly you can sneak up on you. Therefore, it is important to start preparing for retirement financially as soon as possible.
One of the best ways to do that is to invest through a tax retirement account. The most popular retirement account is 401(k) and for good reason. It is relatively simple, does not need much monitoring, provides immediate tax cuts on the funds contributed, and is often accompanied by matching contributions from employers.
However, there are some other types of accounts that are equally valuable. One of them is the Roth IRA, where you can donate post-tax money and receive a tax-exempt withdrawal upon retirement. Should I choose it at 401(k) considering the deferred tax cuts offered by the Roth IRA?
The short answer is no, but it’s not that simple.
No better than Roth Ira’s tax cuts
I mentioned the tax-free retirement withdrawal of the Ross IRA, but looking at the mathematics of how that profit actually works, I look at how valuable it is. Currently, the maximum amount you can contribute to a Ross IRA each year is $7,000, or $8,000 for those over 50 years old. (Every few years, the government has habitually boosted the ceiling in response to inflation, but we don’t know when the next hike will arrive.)
Let’s assume you invest $7,000 a year and invest an average annual revenue of 10% for 20 years. At the end of these 20 years, I have a Roth IRA balance of just under $400,700, but personally I would have donated $140,000. With a standard securities account, whenever you sell your investment, you’re the difference – your capital gains – you borrow taxes on your capital gains. Investing through a Roth IRA will allow you to exempt the full $400,700 tax.
Being able to grow your investment and combined with tax-free withdrawals at the backend is an advantage that you can easily save thousands of dollars of taxes in the golden age.
The Roth IRA offers more flexibility than the 401(k)
One of my most favourite aspects of the 401(k) is that it only offers rather short menus of mutual funds and exchange trade funds to choose from, usually chosen by plan managers. Depending on your investment style and the investment you are interested in, this may be limited.
If you are investing using a Roth IRA, you can purchase stocks or Exchange-Traded Funds (ETFs) that can be made in your regular securities account. This gives you the option to invest in a single stock of interest.
Flexibility is also unstoppable with investment. The Roth IRA also offers more withdrawal flexibility. You can withdraw your contributions – but not your income – at any time without penalty. While it is not recommended to obtain an early withdrawal from your retirement account, tapping on the Ross IRA can help you buy your first home, pay for higher education, cover health insurance premiums while you are unemployed, and more.
Where 401(k) shines
One of the best benefits of the 401(k) is its rather passive nature. With a Roth IRA, you need to actively choose your investment to make a contribution (but you can use automatic forwarding). With 401(k), once you choose how much of your salary you will contribute and which funds you will put in, everything else will automatically be done behind the scenes every time you receive your payment. This makes savings relatively easy for retirement.
The 401(k)s has a much higher annual contribution limit. In 2025, the contribution limit is $23,500, with catch-up contributions of up to $7,500 for those aged 50-59 who set the total limit of $31,000. 60-63 people can contribute up to $11,250 to catch-up, bringing the limit to $34,750.
Most people cannot make the most of their 401(k) contributions each year, but these higher restrictions allow them to invest more money for retirement and are more likely to secure a financial future.
So, do you need to choose a Ross IRA over a 401(k)?
Ideally, you should use both a 401(k) and a Roth IRA. I usually recommend that someone contribute enough to the 401(k) first to make the biggest employer match available. If an employer matches up to 5% of the wages, then no contributions should be made to anything less than 5% – to do so is to leave free money on the table.
But once you contribute enough to get all of those matching funds, you say you’ll switch your focus to make the most of your Roth IRA contributions. Once you have achieved that limit, if you still have the financial capacity to put aside further for retirement, you will return to increasing your 401(k) contribution.
This provides the “best of both worlds” scenario. By contributing to the 401(k), you can reduce your taxable income this year and benefit from immediate tax savings, but you can build nest eggs with a Roth IRA.
Motley Fools have a disclosure policy.
The Motley Fool is a partner at USA Today, providing financial news, analysis and commentary designed to help people control their financial lives. The content is produced independently of USA Today.
Most retirees with the $23,760 Social Security Bonus are completely overlooked
A miscellaneous fool’s offer: If you’re like most Americans, you’re a few years (or even more) behind your retirement savings. But it’s not well known “The Secret of Social Security”It will help you to ensure a boost in your retirement income.
One easy trick can pay you an additional $23,760…Every year! Once we learn how to maximize Social Security benefits, we can retire with confidence in the peace of mind we want. participateStock AdvisorFor more information about these strategies, see
See “Social Security Secrets”»
