Roth IRA Vs. 401K
Do you have a retirement fund? You’re sure to need one, but if you have the option of choosing a Roth IRA or a 401(k), which do you choose? It’s easy for people to advise you to do both, but unless you’re already fairly well off, that may be a daunting proposition. If you have to choose one or the other, how do you decide between the two?
- A Roth IRA is an individual retirement account. An individual can open the account and decide how investments are allocated. Roth IRAs differ from traditional IRAs and most 401(k)s in that they are funded with money that’s already been taxed. Therefore, once you reach the right time to withdraw it, the money is tax-free. Another benefit of Roth IRAs is that you can withdraw the contributions you’ve made at any time, though you will have to wait to access your earnings. Of course, it’s better to leave your retirement account alone, but it’s good to know that you have that money in case of a dire emergency.
- 401 (k)s are retirement accounts sponsored by an employer. This means that, unlike with Roth IRAs, you can’t open a 401 (k) on your own. They also differ from a Roth IRA in that a 401(k) is tax-deferred. This means you can invest pre-tax income and not pay any taxes on that money until after you retire and withdraw your funds. Perhaps the most appealing thing about a 401(k) is that many employers match either part or all of your contribution, which essentially means your employer is giving you free money for your retirement account.
Now that you have a basic understanding of each fund, are you any less confused about which one is right for you? Probably not, because it’s all still pretty confusing. Let’s break it down further, to see how they compare.
- Your eligibility is a major factor. To open a Roth IRA you need taxable income, but to open a 401(k), you need to work for an employer that offers this kind of account.
- Limits on how much you can contribute are different for Roth IRAs and 401(k)s. Both types of accounts have limits, but the limits are much higher for a 401(k).
- Taxes vary depending on which type of account you choose. Remember, if you keep your Roth IRA account for at least five years and don’t withdraw it until you’re at least 59 ½ years old, your money will be tax-free. With a 401(k), you can expect to pay taxes when you withdraw the money.
- Roth IRAs give you some flexibility with your investments. You can set up a Roth IRA through a brokerage firm or using software, at a physical location or online, and invest it however you wish. You can make your own decisions or consult with a financial advisor, or you can set up a robo-advisor to manage your investments for you. With a 401(k) there’s less flexibility. While you’ll be able to change how much you invest and your investment allocations at any time, your employer will limit your options as far as where the money is invested.
- Withdrawing money from a retirement account can be complicated. You’re supposed to leave your money alone when it’s in a retirement account, but typically, you’re allowed to withdraw from both types of account without penalty if you face a hardship like a permanent disability or extremely high medical bills. However, as mentioned previously, you can withdraw the money you’ve contributed to a Roth IRA, and you can even withdraw your earnings early in some circumstances without penalty. On the other hand, early withdrawals from a 401(k) typically come with income taxes and an additional ten percent penalty.
- Both 401(k) accounts and Roth IRAs have required minimum disbursements (RMDs). However, with a Roth IRA, you don’t necessarily have to take money out of your account. When you die, however, your beneficiaries will be subject to the RMD. With a 401(k), the IRA typically requires you to take disbursements at age 70 ½ unless you’re still working.
So the question remains, which type of retirement account is right for you? If your employer offers a 401(k) and matches funds, then that may be your best bet, because it involves free money. Once you’ve maxed out what your employer will match, if you have excess retirement funds, you might want to put them in a Roth IRA. It’s good to know you’ll have money that won’t be taxed when you’re living on a retiree’s fixed income. If you don’t have access to a 401(k), it’s obviously in your best interest to have a Roth IRA. The important thing is to make sure you start putting aside retirement money early and put aside as much as possible.
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