Roth IRA vs 401k
Roth IRA and 401k accounts are common tax-advantaged retirement savings. Although there are differences in terms of employer contributions, investment options, and tax treatment, they both allow employers to grow their savings tax-free. Before investors decide on the retirement account to use, they have to consider a couple of factors. To pick the suitable option, one has to make decisions based on contribution limits and the associated rules. In a perfect situation, however, Investors should be able to settle for both accounts. With that said, this will compare both retirement accounts to help investors choose the option that best works for them.
What is a Roth IRA?
Simply put, a Roth IRA is an individual retirement account that grows savings tax-free. The retirement withdrawals are also tax-free as long as they meet specific conditions. This retirement account was established by William Roth in 1997. Interestingly, Roth IRAs are the same as traditional IRAs, but they differ in the way they are taxed. The contributions people make in their Roth IRAs are also not tax-deductible. They are funded with after-tax dollars and unlike traditional IRAs, individuals don’t get taxed when they withdraw from their Roth IRA accounts. Roth IRAs are recommended for individuals who think their taxes will be higher during retirement as compared to the current time. However, investors need to know that Roth IRAs are not for every person. Here’s the deal. The limit for single persons is $140,000 while that for married couples is $208,003. Individuals that earn more than that cannot contribute to Roth IRA accounts.
Besides, the money people contribute changes from time to time. In 2020, the contribution limit is $6,000, but individuals aged 50 and above have a contribution limit of $7,000. Contributions can be made from spousal IRA contributions, regular contributions, transfers, conversions, or rollover contributions. People can get Roth IRA accounts from banks, brokerage firms, and investment companies.
What is a 401k
A 401k is yet another retirement savings plan that is sponsored by an employer. The account allows workers to save and invest a percentage of their salary before deduction of taxes. Individuals don’t have to pay the taxes until when it’s time to withdraw from their accounts. This plan is named after a section of the United States Internal Revenue Code, which came to act as a supplement to pensions.
With this retirement plan, employees control how they want their money invested. The investment plans include bonds, stocks, and money markets. Usually, employees can make contributions to their accounts via automatic payroll withholding. Moreover, their employers make contributions that match or are equal to the contributions employees make. Before choosing this plan, workers need to know that there is a traditional 401k and Roth 401k. The main difference between the two is how they are taxed.
Technically, a Roth 401k plan allows employees to make contributions with post-tax income. However, they can make withdrawals tax-free. In traditional 401k, on the other hand, workers’ contributions reduce their income taxes during the year they are made. With this plan, investors also get taxed to withdraw. Investors who want this plan need to know that it also has contribution limits. As of 2020 and 2021, the contribution limit a worker can make to his or her 401k is $19,500 annually. And that’s for those aged below 50. However, those aged 50 and above have a contribution limit of $26,000 per year.
On the other hand, the employer contributes $58,000 or all of the worker’s compensation as of 2020. That’s for employees aged below 50. For employees aged above 50, employers have a contribution limit of $64,500. However, keep in mind that employers can only make contributions to a traditional 401k not a Roth 401k. Withdrawals from a 401k can only be made when the owner is at least 59 ½ years. Earlier withdrawals will result in a 10% penalty tax in addition to any other tax that a specific worker owes.
Difference between Roth IRA and 401k
Roth IRA vs 401k is a worthwhile discussion. But what are the differences between these two accounts? Well, for starters, a Roth IRA doesn’t get taxed during withdrawal while a 401k attracts tax deductions during withdrawal. According to experts at SoFi Invest, “Traditional accounts are funded with pre-tax dollars. The contributions are tax deductible and may provide an immediate tax benefit by lowering someone’s taxable income and, as a result, their income tax bill. Moreover, contributions to a 401k are pre-tax. On the other hand, there is no tax deduction for contributions to Roth IRAs. Both accounts also have different contribution limits. A 401k is a retirement account that’s offered by employers to employees while a Roth IRA is an individual retirement plan.
Both Roth IRAs and 401k accounts are popular retirement savings plans. The two, however, differ in different ways, and it is up to employees to choose the most befitting option.