Which is better a Roth IRA or a 401k?
The Bottom Line. In many cases, a Roth IRA can be a better choice than a 401(k) retirement plan, as it offers more investment options and greater tax benefits. It may be especially useful if you think you'll be in a higher tax bracket later on.
401(k) vs.
A Roth IRA offers tax-free investment growth and no RMDs, but there are bigger limits on contributions, and you don't get a tax benefit today. A traditional 401(k) offers the opportunity to put away more and get a tax benefit today, but you will owe taxes later when you withdraw and must take RMDs.
With a Roth 401(k) you'll make contributions with after-tax money, so you won't enjoy a tax break today. In exchange, any money that you withdraw in retirement will be tax-free. In a Roth 401(k), you'll enjoy not only tax-free growth of your investment gains but also tax-free withdrawals.
Roth IRAs have income limits; Roth 401(k)s do not. If you earn too much to be eligible for the Roth IRA, the Roth 401(k) is a chance to get access to the Roth's tax-free investment growth.
If you don't have enough money to max out contributions to both accounts, experts recommend maxing out the Roth 401(k) first to receive the benefit of a full employer match.
This is really where the Roth IRA shines! When you make after-tax contributions to a Roth IRA, it means you've already paid taxes on the money you save for retirement, which helps your savings grow faster because they grow tax-free.
With a Roth IRA, you contribute after-tax dollars, your money grows tax-free, and you can generally make tax- and penalty-free withdrawals after age 59½.
High Fees and Low Control
The unfortunate truth is that 401(k) plans come with high management fees. This eats into your earnings in the long run. These fees are oftentimes hidden among legal jargon, according to the Rich Dad team. Fees can be, but aren't limited to transaction fees, legal fees and bookkeeping fees.
No tax deferral now. The list of cons may be short for Roth 401(k)s, but missing tax deferral is a big one. When faced with a choice of paying more tax now or later, most people choose to pay later, hence the low participation rates for Roth 401(k)s.
Contributions and earnings in a Roth 401(k) can be withdrawn without paying taxes and penalties if you are at least 59½ and had your account for at least five years. Withdrawals can be made without penalty if you become disabled or by a beneficiary after your death.
Do the rich use Roth IRA?
Billionaires gain their advantage over the middle class by combining the backdoor Roth IRA with access. Take Peter Thiel, for example, who managed to turn $2,000 in 1999 money into $5 billion in 2027 money—when he will be 59 1/2 and able to withdraw his investments tax-free.
The Case Against a Roth
For the most affluent investors, the decision may be moot anyway due to Internal Revenue Service (IRS) income restrictions for Roth accounts. For 2023, individuals can't contribute to a Roth if they earn $153,000 or more per year—or $228,000 or more if they are married and file a joint return.
If you've met the five-year holding requirement, you can withdraw money from a Roth IRA with no taxes or penalties. Remember that unlike a Traditional IRA, with a Roth IRA there are no required minimum distributions.
Most experts recommend contributing to your 401(k) for at least as long as you're working.
If you can afford to fund two retirement accounts simultaneously, having both a 401(k) and a Roth IRA helps you maximize your retirement-saving options since they offer opposite tax benefits. You get an immediate tax break with a 401(k) and with a Roth IRA you're essentially guaranteed a tax break in the future.
Some alternatives include IRAs and qualified investment accounts. IRAs, like 401(k)s, offer tax advantages for retirement savers. If you qualify for the Roth option, consider your current and future tax situation to decide between a traditional IRA and a Roth.
Let's say you open a Roth IRA and contribute the maximum amount each year. If the base contribution limit remains at $7,000 per year, you'd amass over $100,000 (assuming a 8.77% annual growth rate) after 10 years. After 30 years, you would accumulate over $900,000.
If you contribute 5,000 dollars per year to a Roth IRA and earn an average annual return of 10 percent, your account balance will be worth a figure in the region of 250,000 dollars after 20 years.
Yes, you can — but double check the rules to make sure you're optimizing your retirement savings.
You may not want to use a Roth IRA if you're a high earner in a high tax bracket who expects to be in a lower tax bracket during retirement. In that case, you may want to contribute to a pretax account that gives you an upfront tax break.
What is best investment right now?
- High-yield savings accounts.
- Certificates of deposit (CDs)
- Bonds.
- Funds.
- Stocks.
- Alternative investments and cryptocurrencies.
- Real estate.
A general guideline is that if you think your tax bracket will be higher when you retire than it is today, you may want to consider a Roth IRA—especially if you're younger and have yet to reach your peak earning years.
High earners may be unable to make direct contributions to a Roth individual retirement account (Roth IRA) due to income limits set by the Internal Revenue Service (IRS). A loophole, known as the backdoor Roth IRA, provides a way to get around the limits.
Key Takeaways
Usually, you would choose to invest your money for long-term financial goals like retirement because you have a longer time frame to recover from stock market fluctuations. If the financial goal is short term, say five years or less, it's usually smarter to park your money in a high-yield savings account.
If you're in a place financially where you can max out a 401(k) and IRA without jeopardizing other goals, it's worth doing.
References
- https://www.ramseysolutions.com/retirement/401k-vs-roth-ira
- https://www.thebalancemoney.com/when-is-the-right-time-to-stop-contributing-to-your-401k-4081737
- https://www.investopedia.com/financial-edge/1211/the-best-alternatives-to-a-401k.aspx
- https://smartasset.com/retirement/average-roth-ira-return
- https://www.nerdwallet.com/article/investing/the-best-investments-right-now
- https://www.investopedia.com/ask/answers/101314/what-are-roth-401k-withdrawal-rules.asp
- https://www.investopedia.com/should-you-save-your-money-or-invest-it-depends-4692975
- https://time.com/personal-finance/article/roth-ira-vs-401k/
- https://www.usatoday.com/money/blueprint/retirement/disadvantages-of-a-roth-ira/
- https://news.bloombergtax.com/tax-insights-and-commentary/roth-iras-have-transformed-into-big-tax-shelters-for-the-wealthy
- https://www.schwab.com/ira/roth-ira/withdrawal-rules
- https://www.nerdwallet.com/article/investing/maxing-out-401k
- https://www.nerdwallet.com/article/investing/roth-401k-vs-401k
- https://www.investopedia.com/articles/personal-finance/040315/when-not-open-roth-ira.asp
- https://www.schwab.com/learn/story/roth-vs-traditional-iras-which-is-right-you
- https://www.bankrate.com/retirement/roth-ira-vs-roth-401k-how-they-differ/
- https://www.nerdwallet.com/article/investing/can-you-have-a-roth-ira-and-a-401k
- https://www.schwab.com/ira/roth-vs-traditional-ira
- https://www.investopedia.com/ask/answers/042214/how-can-i-fund-roth-ira-if-my-income-too-high-make-direct-contributions.asp
- https://finance.yahoo.com/news/rich-dad-robert-kiyosaki-reveals-130028275.html
- https://www.fidelity.com/learning-center/personal-finance/roth-401k
- https://www.cnbc.com/select/why-you-should-have-both-401k-and-roth-ira/
- https://www.marca.com/en/lifestyle/us-news/personal-finance/2023/06/18/648eb65322601dcf4f8b460e.html
- https://www.bankrate.com/retirement/traditional-401k-vs-roth-401k/