IRA vs. 401k vs. Roth: Your Guide to Retirement   

An IRA, 401k, and Roth all have their respective pros and cons, but what is the difference of IRA vs. 401k vs. Roth? When it comes to retirement, it’s important to know what’s best for you.

Working towards a stable retirement is an incredibly difficult task, especially today. It takes a lot of careful planning, financial frugality, and long-term foresight. However, what any retirement plan needs the most is the right beginning. If you begin working and planning for a stable retirement in your 20s, chances are good that you will have the means to retire comfortably.

But how you decide to contribute to your retirement account (and seek contributions to it from other sources) will heavily affect the restrictions and limitations you will encounter while saving for retirement.

There are countless different ways to structure your retirement as you work towards the final years of your time in the labor force. But by far, the three most common ways to plan around retirement involve either an IRA, a Roth IRA, or a 401(k).

But, when it comes to IRA vs. 401k vs. Roth – what is the difference?


IRA vs. 401k vs. Roth

IRAs, or individual retirement accounts, are retirement accounts you can establish yourself to save up and grow your cash at a steady rate to fight inflation and have enough to settle down after retirement.

401(k), on the other hand, is an employer-offered retirement plan, one set up and financed by money withheld by your boss. A 401(k) is also known as a defined contribution plan.

A Roth IRA is an individual retirement account with the simple but important distinction that it allows you to withdraw your money tax-free. There are a few other important distinctions between a traditional IRA and a Roth IRA that would enable the latter to make these tax-free withdrawals.

There are a few other significant differences between an IRA vs. 401k vs. Roth account, as well as other similar retirement plans. Choosing the right one depends on individual circumstances and opportunities, tax considerations, financial difficulties that may lie ahead, financial responsibilities, and more.


What is an IRA?

An individual retirement account is a type of account you can open with a financial institution for the purpose of saving money over multiple decades to work towards a stable retirement. An IRA allows a person to enjoy tax-free growth on their account and deduct the contributions they make to their retirement account from their individual tax return.

Retirement accounts are more than just a shoebox under the bed. They are an investment account wherein you are given multiple investment options to grow your money at low risk, usually through certain funds, stocks, bonds, or property. These investments help you grow your retirement money and beat inflation, versus simply letting the cash sit in a savings account and barely grow.

While the money is eventually taxed when it comes out of the account at the beginning of your retirement, it will be taxed at the rate you qualify for during retirement, which tends to be lower than the rate you might have qualified for while still in the workforce.

In other words, traditional IRAs allow you to turn all of your financial contributions into tax-deferred earnings and lower the taxes you might be paying on those earnings when you finally withdraw them.

IRAs are not necessarily exclusive to other retirement plans. You can save up for both an IRA and put money into your 401(k). Of course, the more retirement plans you contribute money to, the less money you have for bills and living costs. Furthermore, there are other requirements to consider before you can start making your contributions.


What is a Roth IRA?

Roth IRA distinguishes itself from a regular or traditional IRA in that any contributions made to it are taxed first so that when you withdraw them, these contributions will be tax-free income. In other words, through a Roth IRA, you take care of the taxes upfront, so you don’t have to pay them down the road.

Furthermore, a Roth IRA allows you to let your potential earnings grow unimpeded by taxes. Even better, you can withdraw your contributions without penalties. One of the most significant differences between a Roth IRA and a traditional IRA is that early withdrawal penalties can be steep when investing in a traditional IRA.

In a traditional IRA, any withdrawals made before the age of 59 and a half incur both income taxes and a 10 percent penalty. You also have required minimum distributions (RMDs) that you must claim starting at age 72. A Roth IRA has neither an early withdrawal penalty nor any RMDs.

Both traditional and Roth IRAs have specific requirements before you can begin making contributions towards them.


What is a 401(k)?

While an IRA and a Roth IRA require you to make your contributions to your retirement account and decide between upfront tax benefits and tax benefits down the line, a 401(k) involves the employer in the equation.

401(k)s differentiate themselves from IRAs in that a portion of your wages is invested into the account and typically matched by your employer. The investment options for a 401(k) are limited in comparison to most IRAs. However, the gist is the same – put the money in an account, invest it conservatively, allow it to grow enough to avoid loss in value, and hopefully grow to a size that will support you in retirement.

The main differences aside from having multiple sources of contributions are that 401(k) plans have higher limits on contributions and may be easier to save with because the money is being directly withheld from your earnings and never reaches you to begin with, so you don’t need to actively keep yourself from spending what you earn.

You would think that this type of plan wouldn’t be available to self-employed workers, but it is.

solo 401(k) is an option for people looking for another opportunity to benefit from their business and work towards retirement, especially sole proprietors and independent consultants.


IRA vs. 401k vs. Roth IRA: Choosing Between Them

Aside from 401(k)s, IRAs, and Roth IRAs, there are SEPs403(k)s, and other retirement accounts. But when choosing between the three most popular options, you have to ask yourself which you can qualify for, whether you can get your employer to match contributions (not always offered), and whether you prefer tax-free retirement income or tax-deferred payments.


Working With a Financial Advisor

There are countless different factors that heavily weigh into deciding to invest in a retirement account. It’s difficult to recommend one over the other without taking individual factors into account.

You should consider working with a financial advisor or tax specialist when deciding what kind of retirement account to plan with in order to save up for your golden years. Your current income projected earnings and individual tax considerations all impact which retirement account best suits you.