401(k) vs. Roth IRA: Which is the Best Investing Option?

Ravi Kurani
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If you’re serious about investing in your financial future, there’s no shortage of options out there. In fact, it can be very overwhelming.

Two popular options are the traditional 401(k) plan and the Roth IRA. Let's walk through the pros and cons of each.

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Investing in a 401(k).

With a 401(k), you withdraw contributions before paying taxes, deducting that amount from your taxable income. Then, when you reach retirement age and start making withdrawals, you pay the taxes on those withdrawals.

One of the primary benefits of a 401(k) is that most employers will match the amount you put in up to a certain amount (typically 3-6% of your income). This is essentially free money that you don’t want to leave on the table.

Your investment options (usually mutual funds and exchange-traded funds) will vary widely among 401(k) plans. Unfortunately, much of this is not under your control, but your employer's.

There are no income limits to qualify for a 401(k). However, you can contribute up to $20,500 per year ($27,000 if you’re age 50 or older).

Finally, 401(k)s also have required minimum distributions that begin at age 72 or the year you retire, whichever comes later. If you don’t take these distributions, you will pay a 50% tax penalty on that amount.

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Investing in a Roth IRA.

Roth IRAs are a specific type of individual retirement account that’s independent of your employer. With a Roth IRA, you invest the money after taxes, but then that money is allowed to grow tax-free. So when you reach retirement age, you don’t have to pay taxes on any of it, and there are no RMDs.

Additionally, it’s much more difficult to incur a tax penalty when withdrawing from a Roth IRA vs. a 401(k) fund. In general, you can avoid these if the account is at least five years old and the withdrawal is:

  • Made after you turn age 59½
  • Taken due to a permanent disability
  • Made by your beneficiary or estate after your death
  • Used to buy, build, or rebuild your first home (a $10,000-lifetime maximum applies)

With a Roth IRA, you can only contribute $6,000 per year ($7,000 if you’re age 50 or older, so long as your income remains at or below $129,000 if you’re single, or $204,000 if you’re married filing jointly.

What’s the best option?

Both 401(k) and Roth IRAs are excellent investment options. We recommend combining both in the following approach:

  1. Invest in your 401(k) up to the employer match.
  2. Then invest in a Roth IRA up to the contribution limit.
  3. Then invest in a 401(k) up to the contribution limit.
  4. Then invest any additional funds into taxable accounts.

If you’re ready to take that first step and claim the employer match, use the calculator below to see how Matchly can help you.

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