When it comes to planning for retirement, you have many options to choose from based on your financial needs, tax goals, and more. Some of the most common retirement accounts are Roth IRAs and traditional 401(k)s.
Are you wondering whether a Roth IRA or a traditional 401(k) is the right choice for you? This short guide explains everything you need to know.
Understanding the differences between a Roth IRA and traditional 401(k)
Both of these retirement accounts allow your savings to grow tax-free, but they operate in different ways. One of the main differences is that traditional 401(k)s are offered by employers, while Roth IRAs must be opened on your own as an individual. That said, you can have both of these accounts open and contribute to them at the same time.
Let’s take a quick look at some of the primary differences:
Roth IRAs
- Individuals must open an account on their own, usually through a bank or broker.
- These accounts typically offer a large selection of investments.
- You can contribute a maximum of $6,000 per year, or $7,000 if you’re at least 50 years old.*
- Contributions are made with after-tax dollars, so distributions during retirement are not taxed.
- Contributions cannot be deducted when you file your income taxes.
Traditional 401(k)s
- These accounts are offered by employers. In some cases, the employer offers a “match,” which means they will match your contributions up to a certain percentage of your income.
- The investment selection is limited, and your employer maintains control of the plan and investment costs.
- You can contribute a maximum of $19,500 per year, or $26,000 if you’re at least 50 years old.*
- Contributions are made with pre-tax dollars, so distributions during retirement are taxed.
- You can deduct your contributions when you file your income taxes.
*As of 2021. These amounts may change by year.
Which one is right for you?
When deciding which retirement option is best for you, you’ll need to consider several factors:
If a traditional 401(k) is an option, is your employer offering a match?
If you have access to an employer-matched 401(k), we suggest maximizing your contributions in order to get the highest match possible. This is essentially free money that you don’t want to pass up. Keep in mind that when you change jobs, you can simply roll over the money into another account.
If your employer doesn’t offer a match, consider starting with a Roth IRA. This option gives you a wider range of investment choices, as well as more control over the account.
Would you rather pay taxes on the money now or while in retirement?
As mentioned above, contributions to a traditional 401(k) are made with pre-tax dollars, so distributions during retirement are taxed as ordinary income. The reverse is true with Roth IRAs. This is definitely something to consider based on what your income will be during retirement.
Do you want to save more aggressively for retirement? Do you have extra funds to do so?
Some people choose either a traditional 401(k) or a Roth IRA, simply because they don’t have extra funds to contribute to more than one retirement account. However, if you can contribute extra funds, you should consider opening both types of accounts.
If you have an employer-matched 401(k), we suggest getting the match, and then maxing out your IRA contributions for the year. After that, you can continue contributing to your 401(k).
Take control of your future and plan for retirement today
VillaNova is a full-service insurance brokerage and consulting firm serving King of Prussia, Pennsylvania. If you’re ready to plan for your future, contact us today to get started. We offer customized solutions that allow you to meet your financial goals for retirement.