401k vs Roth IRA

In this article we’ll be taking a look at the common 401k vs Roth IRA comparison. Both types of retirement arrangements are very popular so it’s worth looking more in-depth at the two side by side.

401k vs Roth IRA: The 401k

We’ll start the 401k vs Roth IRA evaluation by looking at what a 401k is. It is one of the oldest retirement plans, really hitting popularity in the early 1980s. The idea was simple, contribute a part of your income to your 401k and let that grow until retirement, unfortunately many people have failed to take full advantage of the account and have been left with a short supply of savings.

The general benefits that the 401k offers are a high contribution limit, pre-tax contributions like a Traditional IRA, and a wide umbrella of eligibility. The most enticing benefit that we’ll be discussing more is the employer match, where some employers offer to match a certain amount of your contribution, which is essentially free money for your retirement.

401k vs Roth IRA: The Roth IRA

I encourage you to read our other articles about Roth IRAs if you would like to learn more in detail about them, but here is a quick recap. A Roth IRA is one of the newer types of retirement arrangement that was made to give owners more flexibility and freedom. The main features are easy withdrawals with few restrictions, and mostly tax-free distributions later on.

401k vs Roth IRA Side By Side Comparison

Aspect Roth IRA 401k
Contributions You may not be able to contribute at all, or only be allowed to contribute a reduced amount if your taxable income is too high.  You pay tax on your contributions, but rarely have to pay further taxes later (See Roth IRA Contribution limits 2012). Your taxable income is irrelevant to your contribution eligibility.  As long as you have an income you can contribute.  There are usually tax-deferral options so you can save money on your contributions that would have gone to taxes.
Contribution Limits You are limited on how much you can contribute based on your taxable income (See Roth IRA Income limits 2012).  The maximum contribution in 2011 and 2012 is $5,000 or $6,000 depending on how old you are. Very high limits, in 2011 the maximum contribution was $16,500, which has risen to $17,000 for 2012.  Much like the Roth IRA this number will keep rising with inflation.
Withdrawals The only account do let you do so, the Roth IRA lets you withdraw previous contributions at any time penalty free.  If you have owned the Roth IRA for at least 5 years and are 59.5 years old you are allowed to take out the earnings as you please with no fees. You will have to pay taxes on your distributions according to the income tax bracket that you fall into.  There are heavy restrictions and penalties (usually 10%) if you try to withdraw earnings early, however you can take out contributions once you are 59.5 years old.
Distribution No minimum distribution at any age, you are free to withdraw as you wish. When you turn 70.5 years of age you are mandated to take minimum distributions out or face a penalty.
Other The flexibility also brings along other benefits like the $10,000 tax-free withdrawal of earnings to finance a first time house purchase. Even though contributions are already tax-deferred, some of them may be tax-free as well if they meet certain qualification standards.Also, many employers offer an employer contribution match, which means that for every $XX you contribute they will add the same to your account for free.

As you can see in the 401k vs Roth IRA comparison there are some large differences in the 2 accounts, choose the best one for you, or even choose both if your situation permits it.