Here’s Why You Should Invest in Both a Roth IRA and 401(k) at the Same Time

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When it comes to choosing between a 401(k) and a Roth IRA, it doesn’t have to be one or the other. In fact, many experts recommend using both retirement accounts to diversify your tax benefits and take advantage of the perks that each account offers.

Both Roth IRAs and 401(k)s have become two of the most popular retirement savings vehicles. Both allow workers to save for retirement in a tax-advantaged way, but they differ in terms of how you can set up an account, their contribution limits, their investment options, and more.

Are you wondering which retirement account is best for you? Wonder no more because you should be using both, and here’s why. We’re exploring the differences between a Roth IRA and a 401(k), and we’ll show you how to take advantage of both accounts.

401(k) vs. Roth IRA: What Are The Differences?

401(k)

A 401(k) is an employer-sponsored retirement plan that’s offered by many private-sector employers in the U.S. In most cases, your 401(k) contributions are withheld from your paycheck pre-tax, meaning they reduce your taxable income. Then, the money gets deposited and your investments grow tax-deferred in the account. Your withdrawals are subject to income taxes during retirement depending on your tax rate at the time.

“What’s neat about how these work is your contributions are directly pulled from your paycheck, so it’s a seamless way for someone to save for retirement and allows workers to have access to traditional and Roth vehicles, if the employer allows it,” said Mindy Yu, Director of Investing at Betterment.

In 2022 the IRS allows workers to contribute up to $20,500 to a 401(k) plan. For workers 50 and older, there’s an additional catch-up contribution of $6,500. 

“The other benefit is that some employers do match your contributions, which is a large benefit,” Yu said. “Employer matches are a way for your earnings to grow because it’s essentially free money or a 100% return on your contributions up to that match.” If you are eligible for an employer match, make sure that you are putting enough money into your 401(k) to be eligible for the match.

Roth IRA

A Roth IRA is a type of individual retirement account that allows workers to save for retirement outside of an employer-sponsored plan. Someone with earned income can open a Roth IRA with nearly any popular brokerage firm.

Roth IRA contributions are made after-tax, meaning they don’t reduce your taxable income in the current year. However, once the money goes into the account, you’ll never pay taxes on it again. Your investments grow tax-free during your working years, and you can take tax-free withdrawals at 59 1/2.

“Contribution limits are definitely lower compared to a 401(k),” Yu says. “For 2022, it’s $6,000 compared to the limit of $20,500 for a 401(k).”

Just like a 401(k), a Roth IRA allows for a catch-up contribution for workers 50 and older, but in this case, it’s only an additional $1,000.

One important provision of a Roth IRA is that not everyone can contribute. First, you must have earned income to contribute to an IRA. And while the maximum contribution is $6,000, you can only contribute up to 100% of your earned income. So if you earn less than $6,000 in a given year, you can only contribute what you made. 

Another important restriction on Roth IRAs is that you can only contribute if you’re under a certain income limit. In 2022, once your income surpasses $144,000 for single filers, or $214,000 for joint filters, you won’t be able to contribute without doing a backdoor Roth IRA, which is where you contribute $6,000 to a traditional IRA, invest it and convert it to a Roth IRA.

This chart shows the differences between a Roth IRA and a 401(k):

401(k)Roth IRA
Plan SponsorshipEmployer-sponsoredIndividual
Tax AdvantagePre-taxAfter-tax
Contribution Limit$20,500 per year
$6,500 catch-up contribution
$6,000 per year
$1,000 catch-up contribution
Income LimitNone$144,000 for single filers (MAGI)
$214,000 for joint filers (MAGI)
Employer MatchYesNo
Required Minimum DistributionsYesNo

Pros and Cons of 401(k)s

There are many pros and cons to a 401(k). Take a look at the chart below to see what they are:

Pros

  • High contribution limit

  • Potential for employer match

  • May allow for both pre-tax and Roth contributions when you use a Roth 401(k)

Cons

  • Limited investment options

  • Required minimum distributions at 72

  • May be subject to a vesting period for employer contributions

Pros and Cons of Roth IRAs

There are many pros and cons to a Roth IRA. Take a look at the chart below to see what they are:

Pros

  • Tax-free investment growth and withdrawals

  • Wider variety of investment options

  • No required minimum distributions

Cons

  • Low contribution limit

  • No potential for employer match

  • Subject to income limitations

Is it Better to Invest in a 401(k) or Roth IRA?

If you’re wondering whether it’s better to contribute to a 401(k) or a Roth IRA, don’t because you should be investing in both. Experts agree that the first account you should take advantage of should be a 401(k), if you’re eligible through one at your job. Make sure you are putting enough to get the employer match first.

“As I mentioned earlier, an employer match is free money that you don’t want to miss,” Yu said.

Then move onto your Roth IRA. Try to max out the $6,000 a year, if you are eligible, and if you have enough money after that, go back to your 401(k) and max it out to the entire $20,500 annual limit.

Pro Tip

Don’t feel the need to pick between just a 401(k) or a Roth IRA. If you can, invest in both and take advantage of time and compound interest.

“I think if you have the ability to contribute to both, you should,” says Chloe Elise, certified financial coach and founder of Deeper Than Money. “I recommend you first take advantage of contributing enough to your 401(k) to get any kind of employer match. Then, I would focus on maxing out your Roth IRA while you are within the income limits.”

Elise also points out that if you want to take advantage of Roth IRA contributions but aren’t eligible for a Roth IRA, you can ask your employer if there’s a Roth contribution option within the company 401(k). You’ll get the same tax advantage without being limited by your income.

Which is Better for Taxes? A Roth IRA or 401(k)?

We’ve talked briefly about the different tax implications of a 401(k) and Roth IRA, but let’s dive a bit further into them here. As we mentioned, a 401(k) and a Roth IRA have different tax advantages.

In most cases, 401(k) contributions are made pre-tax, meaning they reduce your taxable income — and, therefore, your tax burden — in the current year. The money grows tax-deferred while it’s in your account, and you’ll pay taxes on your 401(k) withdrawals at your ordinary income tax rate at retirement.

A Roth IRA, on the other hand, allows you to make your contributions after taxes. While there’s no tax advantage in the current year, your money grows tax-free in the account and you can withdraw both your contributions and earnings tax-free during retirement.

So which tax advantage is better? Traditional 401(k) contributions are generally more beneficial for taxpayers with a high income today who expect to have a lower income during retirement. In other words, you can get a tax break today if your tax rate is high, and then defer those taxes until you’re in a lower tax rate. And vice versa.

A Roth IRA is better for taxpayers who expect to be in a higher tax bracket during retirement. You can pay the taxes today while your tax rate is lower, and then enjoy tax-free withdrawals while your tax rate is higher during retirement.

“For many young people, the beauty of a Roth IRA is that they are paying tax on the money today while they are potentially at the lowest tax brackets of their life,” Elise says.

Unfortunately, it’s impossible to know for sure whether your income tax rate will be higher or lower during retirement. Elise notes that many experts believe tax rates, in general, will be higher decades from now. As a result, paying the lower tax rate today is beneficial.

What about a Traditional IRA?

The 401(k) and Roth IRA are two of the most popular choices available for retirement savings, but we’d be remiss if we didn’t also mention the traditional IRA. 

This account combines some benefits of a 401(k) with a Roth IRA. Traditional IRA contributions are pre-tax, meaning they allow you to reduce your tax burden in the current year and defer the taxes until retirement. And like a Roth IRA, a traditional IRA offers a wider selection of investments than a 401(k).

Of course, a traditional IRA also has the downsides of a Roth IRA. There’s a low contribution limit of $6,000. Additionally, while anyone can contribute to a traditional IRA, not everyone can deduct their contributions. If you are eligible for an employer-sponsored retirement plan — or your spouse is — then you’re subject to income limitations on your traditional IRA deduction.

“Traditional IRAs can be deductible or non-deductible, so I would also caution you to check to see if you are even eligible to deduct your IRA contribution,” Elise said.

So who is a traditional IRA right for? First, a traditional IRA is a great option for anyone who doesn’t have access to a retirement plan through work, since you won’t be subject to the income limits on your contribution deductions. 

It also may be a necessary tool for someone doing a backdoor Roth IRA. With this type of transaction, you contribute money to a traditional IRA and then convert those funds to your Roth IRA. It’s a way around the income limits on a Roth IRA, especially for those who can’t deduct their traditional IRA contributions anyway.