Roth IRA vs. 401(k): Which is Right for Me?


It’s Finance-February!

Now is always the best time to prepare for your financial future, and what better way to do that than exploring retirement plans? Below, Method HRM explores the great debate: Roth IRA vs. 401(k).

Benefits of a 401(k)

Beginning your journey toward retirement savings should start by becoming informed. Understanding the benefits offered from a Roth IRA and a 401k is a great first step.

A traditional 401K has the benefit of tax-deductible contributions. This means the money you earned and investing in a 401k won’t be taxed. A 401k is a great option for higher-wage earners looking to pay taxes later when they have lower incomes.

For many, especially those new to investing, a company’s retirement plan can be a valuable tool to build a stable financial future. To help guide you toward which is the right option for you, here are five benefits to a 401(k) plan.

1. Tax Advantages: Contributions made to a traditional 401(k) plan are taken directly from your paycheck before federal income taxes are withheld. As pre-tax contributions, your total taxable income is lowered. TurboTax explains, “you will owe less in income taxes, regardless of whether you itemize or take the standard deduction.”

2. Gives You Control: For many, a 401(k) is appealing because you can contribute as much or as little as you wish to your account based on plan and IRS limits. You also have the flexibility to change your contribution levels whenever you like depending on your situation.

3. Affords You Time: When you become an early investor, you have more time to grow your money. Among the main advantages of investing in a 401(k) early is compound interest. Compound interest is earned interest on the principal amount of an investment, including any accumulated interest, or when you earn interest on interest. Compounding can make a big impact on your long-term investment and is significant when saving for retirement.

4. It Goes Wherever You Go: When you contribute money to a 401(k) plan, even if you change jobs, the earnings are yours. Depending on plan type, there exist ways to keep your retirement plan invested while growing on a tax-deferred basis.

5. Easy Payroll Deductions: With a 401(k), you’re able to make automatic contributions directly from your paycheck. This makes saving streamlined and effortless. Deductions are made before getting paid, so most don’t miss their money and feel satisfied knowing they’re taking steps to secure a solid financial future.

Benefits of a Roth IRA

Whereas both types of accounts allow your savings to grow tax-free, deciding on a Roth IRA vs. a 401(k) can ultimately come down to how you choose to invest. A 401(k) will offer a tax-deferred plan through a workplace, while a Roth IRA is an individual plan where your money is taxed before it goes in.

The Roth IRA differs from a 401(k) because the contributions are taxable, but the earnings from the investment are not. When you retire and take distributions, they will not be taxed.

Below are five benefits to putting your money toward a Roth IRA over other retirement accounts.

1. Tax-Free Retirement Income: With a traditional IRA, you’re offered an upfront tax break, meaning contributions may be deducted in the year they’re made to the account. Pulling money out of a traditional IRA in retirement signals owed income taxes. With the Roth IRA, you’ll have to wait longer for the tax-savings payoff, but it’s worth it if you can expect their tax rate will be higher later than it is now. Having taken care of your taxes upfront means you won’t have to worry about this later — withdrawals made in retirement signal money that is yours, free and clear.

2. Access Without Penalty: Withdrawing money from a traditional IRA before age 59 ½ signals facing an income-tax bill on top of a 10% early withdrawal penalty. With a Roth IRA, you’re able to avoid both, given that the money withdrawn comes from your investments contributions and not your earnings. If access to an emergency fund could be something needed in the future, a Roth IRA may be a smart choice.

3. Less Age Restrictions for Withdrawals: A Roth IRA is RMD-free (required minimum distributions), and original account holders are free to let their money remain where it is as long as they are alive. This means investments can grow tax-free, and investors can avoid selling assets at a bad time. Unlike traditional IRAs, a Roth IRA means no forced withdrawals.

4. Better Terms for Heirs: If considering what’s in the best interest of your heirs, a Roth IRA could make the most sense. NASDAQ says the “distributions from an inherited Roth IRA are tax-free. And while non-spouse beneficiaries of a Roth IRA are subject to annual minimum withdrawal requirements, the Roth offers surviving spouses another special perk: no required minimum withdrawals.”

5. Nearly Everyone Can Contribute to a Roth IRA: An existing traditional IRA (or a nondeductible IRA) can be converted into a Roth through a strategy known as the backdoor Roth IRA. NerdWallet says the catch, however, is, “you’re required to pay income taxes on any contributions that were deductible, as well as any investment gains within the account before the conversion. Once you’re done settling your tab, voila, you have a Roth replete with all the built-in benefits.”

What Should I Know Before Deciding on My Retirement Plan?

It’s never too early to begin planning for retirement. While the above information offers an overview of some of the benefits to the 401(k) and Roth IRA plans, respectively, a financial advisor for retirement planning would lend valuable insight for those new to investing. Compare several plans to identify which would offer the best benefits taking into account your present and future circumstances.

Method HRM encourages everyone to invest in their future. Either option is great when you compare it to not saving at all.