Did you know that saving for retirement in a Roth IRA might be better than a 401k?
There are hardly any instances where I would not recommend the benefits of a Roth IRA in addition to a 401k, especially for young people saving for retirement in their twenties and thirties.
Don’t get me wrong, I love 401k’s too!
They allow you to save money on taxes now and give your employer a chance to save toward your retirement as well.
But if you’re already contributing enough money to get your full employer 401k match, it might make sense to invest additional money into a Roth IRA instead of putting more money into your 401k.
A Roth IRA is also a great choice for those who might not have a 401k match, or a 401k at all through their employer!
There are a handful of reasons why a Roth IRA is better than a 401k, and I’ll highlight some of these unique benefits in this article!
If you’re confused on whether or not you should open a Roth IRA in addition to your 401k, these reasons will shed some light on how powerful Roth IRA’s are, and convince you to open one if you haven’t yet!
What is the Difference Between a Roth IRA and a 401k?
First of all, what the heck is the difference between a Roth IRA and a 401k? They’re both retirement accounts, right?
The biggest difference between a Roth IRA and a 401k comes down to how they’re taxed and how they’re owned.
A Roth IRA is not tied to your employer and contributions grow tax free. So anyone can open one, regardless of employment retirement options.
On the other hand, your 401k is tied to your employer and is typically a pre-tax account.
This means that you’ll get a tax break now (in addition to the standard deduction), and you’ll pay taxes in retirement upon withdrawal.
I’m personally a huge fan of the tax-free growth benefits of the Roth IRA for younger people because most of the money inside of the account will be growth by the time you retire.
Although, all of that tax-free growth comes at the price of your current tax bill (the IRS unfortunately won’t completely let you off the hook).
A traditional 401k will minimize your current tax bill, which gives you more money in your paycheck each month.
Can You Contribute to a Roth IRA and a 401k?
Yes! And I highly recommend that you do.
It’s a great strategy for tax diversification in retirement.
You’ll have a pile of traditional money (that you’ll need to pay taxes on as earned income) and a pile of Roth money that you can take out tax-free.
There are ways to minimize those traditional 401k taxes in retirement, but it’s also helpful to have some Roth money that you can tap into tax-free as well.
Bonus points if your use those tax savings to fund your Roth IRA each year!
How is a Roth IRA Different than a Roth 401k?
Roth 401k’s have become more popular recently, meaning that you contribute money after paying taxes and it will grow tax-free!
Your employer matching contributions will always be pre-tax, however.
Think of your Roth 401k as the best of both worlds. It’s taxed the same as a Roth IRA, but has the same rules and contribution limits as a regular 401k.
I still recommend opening a Roth IRA even if you have a Roth 401k at work, for the same reasons listed below.
Here are some of the main differences between a traditional 401k, Roth 401k, and Roth IRA:
| Traditional 401k | Roth 401k | Roth IRA | |
| Tax break now? | Yes | No | No |
| Tax-free growth? | No | Yes | Yes |
| Contribution Limit | $19,500 per year | $19,500 per year | $6000 per year |
| Income Limit | No | No | Yes, high-income earners are restricted or ineligible to directly contribute |
| Tied to employer? | Yes | Yes | No |
| Funded by payroll deduction? | Yes | Yes | No |
| Earliest age to withdraw funds without penalty? | 59.5 | 59.5 | Contributions can be withdrawn at anytime after you’ve held the account for 5 years, growth can be withdrawn at age 59.5 |
And if all of this confuses you and you want an overall guide on saving for retirement, check out this post: The Complete Beginner’s Guide to Saving for Retirement
5 Ways a Roth IRA is Better Than Your 401k
I want to disclaim that the purpose of this post is not to shame 401k’s.
I love 401k’s and think they are the easiest way for Americans to build wealth for retirement.
Once you are saving enough in your 401k to get the full employer match and have additional money to invest, these 5 reasons will show you why a Roth IRA is the way to go.
If you don’t get your 401k match, I will come find you.
Invest up to the match in your 401k. Then, read this post to learn why a Roth IRA is better than a 401k for investing more money beyond that.
Or if you don’t have a 401k, these reasons should convince you to open a Roth IRA!
You still need to save for retirement even if your employer doesn’t offer a 401k.
#1 – A Roth IRA Gives You More Control Over Your Account
Have you ever logged in to your 401k’s website and looked at the choices you have to invest in?
You probably only have a dozen or so to choose from, and even fewer good options. Most 401k’s have relatively high management fees as well.
Opening a separate Roth IRA gives you a smorgasboard of fund options.
You have the choice to select from thousands of diversified, low-cost index funds instead of whatever BS high-fee funds are available in your 401k.
You can pick the best ones out of a much longer list than what’s available in your 401k.
Better funds = better performance = more money in retirement!
#2 – A Roth IRA Doesn’t Have Required Minimum Distributions
Did you know that the IRS will force you to start taking money out of your 401k when you turn 72?
A required minimum distribution is the minimum amount you are required to withdraw from certain retirement accounts.
This amount depends on a lot of factors, but ultimately it means that you aren’t allowed to leave your retirement investments alone and let them compound indefinitely.
The IRS requires you to begin taking distrubutions from your 401k at age 72, even if you are still working or don’t need the funds just yet!
When you withdraw from a traditional 401k, you’ll also pay income tax on the amount withdrawn.
The IRS doesn’t want you to get rich from perpetual compounding and avoiding income taxes for too long (remember in a traditional 401k they haven’t gotten your money yet!)
This is your money that you worked hard to save, and now you don’t even get to decide when to withdraw it?
I know that most of us will probably be planning to use money from our 401k’s by the time we’re 72, so this probably won’t affect you too much unless you have a ton of other passive income and don’t need to tap the 401k just yet.
But this rule is pretty annoying and can change your retirement strategy to optimize for tax expenses.
The cool thing about the Roth IRA is that there are no required minimum distributions.
You already paid the IRS when you put the money in the account, so they don’t care when you use the money (since they don’t get a cut when you withdraw).
You’ll have full control over your money and when you withdraw it. Pretty neat!
#3 – You Won’t Pay Income Tax on Investment Gains in a Roth IRA
Another reason why a Roth IRA is better than a 401k is that the Roth IRA grows tax-free!
We talked about this in the previous sections, but I wanted to explain the impact of this a little more.
If you contribute $500 a month into a Roth IRA for 35 years, you’ll have just over $1 million!
The best part? You’ve only contributed $210,000 of your own money, and the other $800,000+ is GROWTH.
Having all of that money at your disposal dollar-for-dollar will literally save you hundreds of thousands of dollars in taxes.
Or if you let the money sit for a little longer, it will roughly double every 7 years even if you don’t contibute a single penny more.
This is why I love Roth IRA’s for young workers. Since you have so much time until retirement, your money sits and grows for literal decades.
And then you don’t have to pay taxes on those gains!
For the most part, your income will increase as you excel in your career and I’d bet serious money that taxes will also increase in the future.
Roth money is so powerful that the government only lets you contribute $6000 per year.
If they’re limiting your contributions that much, you know it’s good.
#4 – You May Not Always be Eligible to Contribute Directly
Because Roth IRA’s are so awesome, the IRS has limits on who is eligible to contribute (whomp, whomp, whomp).
Here are the basic rules (you can read the full details on Investopedia):
- You must contribute earned income from that year (from a job or self-employment, not investment income)
- The annual contribution limit is $6000 per year
- You must earn less than $125,000 per year ($198,000 if you’re married filing jointly) to contribute the full amount
- If you’re above the income limit, there are workarounds to contribute to a Roth IRA indirectly
If you meet these eligibility requirements, you should open and begin contributing to a Roth IRA ASAP!
If you plan to make more than $125,000 or become ineligible to contribute in the future, you should contribute now while you are eligible.
Your 401k will always be there no matter how much money you make.
You cannot become ineligible to contribute to a 401k based on your income.
#5 – Roth IRA’s Have a Wider Contribution Window
Did you know that the deadline to contribute to your Roth IRA for 2021 is not December 31st?
The Roth IRA contribution deadline is April 15th of the next year.
This means that you have from January 1st, 2021 through April 15th, 2022 to make your 2021 Roth IRA contributions.
Your 401k only gives you the full calendar year to make contributions through payroll deductions.
Having a longer window to make your retirement contributions is just one more reason why a Roth IRA is better than a 401k.
Summary
Now you know all about the advantages of a Roth IRA and why it is better than your 401k.
Between tax-free growth, more fund choices, and no required minimum distributions, there is no excuse to not open one right now if you’re eligible.
Here’s a quick summary of the 5 reasons why you might want to contribute more retirement savings to a Roth IRA instead of your 401k:
- More control over your investments in a Roth IRA
- No required minimum distributions
- Tax-free growth
- You might not always be eligible to contribute directly (so do it while you can!)
- The wider contribution window (January 1st – April 15th of the next year)
Maxing out our Roth IRA’s each year is a huge financial priority for my husband and I.
Even though we have (and still contribute to) 401k’s at work, the Roth IRA benefits are too good to pass up.
I hope this post helped illustrate those benefits to you too!
Have you opened a Roth IRA yet? Tell me about it in the comments below!
-Megan
Read next: Roth IRA 101: A Complete Guide to Investing for Beginners
Megan Hetisimer
Megan is an automotive engineer, newlywed, and personal finance blogger from the midwest. She found her passion for personal finance after starting her first “real job” after graduating college. Now, she helps other young professionals become more intentional with their money in order to build wealth for financial freedom. In her free time, she loves to travel, hike, and play euchre with her family. Read more about her story here.
