Skip to main

IRA vs Roth IRA vs 401(k): What’s the Difference?


By The Human Interest Team

Editorial Policy

To support a comfortable lifestyle in your golden years, you will need to save money to supplement your retirement. Without a cushion to fall back on, your monthly income alone won’t allow you to stop working completely as you age. Saving for your future is no longer an option. It’s a necessity.

The key to monetary stability in your later years is retirement planning. Before you begin, you need to understand the major retirement accounts that are available and how they compare to one another. Determine how an IRA compares to a Roth IRA and how an IRA compares to a 401(k). With these comparisons, you can decide which would be the best benefit to your future.

What Are the Differences Between an IRA, Roth IRA, and 401(k)?

The difference between an IRA and a Roth IRA is how contributions are made. Your contributions to an IRA are pre-tax and may be deductible from your taxes for the year in which you contributed. The Roth IRA differs in that your contributions are taxed before they’re deposited, and these contributions cannot be deducted. Once you complete a withdrawal from your IRA account, you are susceptible to a tax penalty, whereas the Roth IRA does not carry tax penalties for withdrawals made after retirement.

A 401(k) is similar to an IRA in that your contributions are all pre-tax, and you do not pay tax on that amount until you start withdrawing from the fund. A 401(k) is different from an IRA in that it’s employer-sponsored with higher limits for your annual contributions. Investment choices for this retirement plan are generally more limited than other options.

What Is an IRA, and How Does a Traditional IRA Work?

An IRA is a type of personal retirement account. It has annual limits on contributions based on your age: a maximum of $6,000, pre-tax, annually if you are less than 50 years old and $7,000 if you’re 50 or older. You will be responsible for taxes once you begin withdrawals.

IRA Advantages:

  • Broader investment options than a 401(k)

  • Tax-deductible contributions

  • The fund grows while taxes are deferred

IRA Disadvantages:

  • Lower contribution limits per year

  • Disbursements are taxed

  • Early withdrawal penalties in most IRAs

How Does a Roth IRA Work?

The Roth IRA has the same annual contribution limits as an IRA. The main differences between the two are in the contributions and taxation. If the individual believes they will be in a higher tax bracket upon retirement, a Roth IRA is a good option. These accounts are not affiliated with the person’s job and can be opened independently. The investment firm will set up the Roth IRA directly with the individual.

Marital status is important when opening a Roth IRA as there are income limits that determine eligibility to participate in this plan. Annual contribution limits for this plan are also set at $6,000 if you are under age 50 and $7,000 if you are 50 or older. Contributions are made post-tax, so disbursements will not be taxed upon retirement.

Withdrawing your funds before you are 59 1/2 years old will carry a penalty of 10% in most cases. These types of withdrawals from a Roth IRA are not assessed a penalty:

  • Withdrawals due to disability

  • Death of the owner of the Roth IRA

  • Payment of medical expenses that are not reimbursed beyond 7.5% of Adjusted Gross Income of the account owner

  • Payment of medical insurance if not employed for more than 12 months

  • First-time homebuyer purchase

  • Qualified expenses for higher education

  • Back taxes due to IRS levy

Advantages to a Roth IRA:

  • No tax liability when withdrawing

  • Access to funds at any time after five years

  • Early withdrawal penalty exceptions in place

  • No minimum distribution limit

  • Greater investment choices

Disadvantages to a Roth IRA:

  • Cannot use contributions for tax deductions

  • Income limits on eligibility

  • Contribution limits are fairly low

  • Not employer-sponsored and no matching

How Does a 401(k) Work?

A 401(k) is an employer-sponsored retirement plan, but individual 401(k) accounts are also available to people who are self-employed. Employers and individuals in for-profit businesses also qualify for a 401(k) plan. Contributions are made pre-tax, while disbursements are taxed. These plans have higher contribution limits than an IRA: $20,500 annually for those under 50 and $27,000 if you are 50 or older.

Employers have the option of making contributions to employee 401(k) accounts but are not obligated to do so. The employer match is typically a percentage of the employee contribution up to a set percentage of the annual salary. An example would be an employer match of 50% of the employee’s contribution up to 6% of the total salary.

Why Make the Comparison of an IRA vs a Roth IRA vs a 401(k)?

Comparing IRA, Roth IRA, and 401(k) options, and outlining their advantages and disadvantages, will enable you to tailor your retirement savings to your current lifestyle.

If yearly tax deductions are a better option for you, choosing an IRA would allow you to deduct contributions during that tax year. In contrast, the Roth IRA does not allow for tax deductions on contributions, but you would not owe taxes on your disbursements. This option may work better in your golden years based on your long-term planning.

An IRA and a 401(k) have both similarities and differences. Both allow pre-tax contributions, but the amount you can contribute differs. As the 401(k) is employer-sponsored, the employee is able to contribute up to $20,500 annually if they are under 50 years of age and $27,000 if they are 50 or older. On the other hand, IRA contribution limits are $6,000 annually if the account holder is under 50 years old and $7,000 for those who are 50 or older.

Investment options for an IRA versus a 401(k) are broader. Typically, 401(k) plans tend to offer around 20 options to choose from while IRAs have significantly more choices. If you prefer to diversify your investments over a variety of areas, the IRA may suit your needs.

Comparing these different retirement options from every angle and determining which is the best fit is well worth the time and effort. Reach out to the professionals at Human Interest to learn which option is best for you.

We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment education, and integration with leading payroll providers.

Subscribe to our Retirement Roadmap newsletter

Retirement isn’t just a destination. It’s a journey, and we’re here to help you. Our newsletter delivers succinct and timely tips, reviewed by Financial Advisors, to help you navigate the path to financial independence.

By providing your email above or subscribing to our newsletter, you agree to our Privacy Policy. You also elect to receive communications from Human Interest.