What are the differences between a 401k, Traditional IRA, and Roth IRA?

401k’s and IRA’s (Traditional & Roth) are financial arrangements put in place to provide a tax benefit for retirement savings.

Below is a breakdown of the 2024 tax year benefits & negatives to 401k, Traditional IRA, and Roth IRA accounts.
 
401K’S
Benefits:

• Employer matching
• Higher contribution levels ($23,000 for under age 50…$30,500 for over 50)
• Contributions are made pre-tax (or “tax deferred”)…lowers taxable income in contribution year
• No income limits for contributions, other than earned income must be greater than contribution

 
Negatives:

• Normal distributions are taxed as income
• Forced distributions at age 70 ½
• Limited to employer fund availability

 
Traditional IRA’s
Benefits:

• Contributions are pre-tax (or “tax deferred”)…lowers taxable income, like 401k’s
• You can pick the funds (not limited by employer’s fund managers)
• No income limits for contributions, other than earned income must be greater than contribution

 
Negatives:

• Normal distributions are taxed as income
• Forced distributions at age 70 ½
• Contribution limited to $7,000 for under age 50…$8,000 over 50 (earned income must be > contribution)
• Contributions may be limited by other contributions (i.e. - 401k, Roth IRA’s)
• No employer matching

 
Roth IRA’s
Benefits:

• Normal distributions are tax-free (contributions & growth)...hedges against higher future tax rates
• No forced distribution at age 70 ½
• You can pick the funds (not limited by employer’s fund managers)

 
Negatives:

• Contributions are made post-tax, so no upfront tax benefit
• Contribution limited to $7,000 for under age 50…$8,000 over 50 (earned income must be > contribution)
• Income limitations** - (Adjusted Gross Income) of $161k for Single; $240k for Married Filing Joint
• Contributions may be limited by other contributions (i.e. - 401k, Traditional IRA’s)
• No employer matching

 
** While Roth IRA’s do have an income limitation, there's a “Backdoor” strategy to still allow contributions even if income exceeds limitations. Feel free to contact us if you have questions on how you can contribute to a Roth IRA in this situation.
 
The contribution limits for IRA's applies to all IRA’s. So if the annual contribution limit for your age is $7,000 per year...you can contribute a cumulative total of $7,000 between Traditional and Roth IRA’s.
 
Strategies to Consider

• Contribute to your 401k up to the employer match amount; and then contribute to a Roth IRA.
• Some suggest contributing to a Roth while in lower tax brackets, and a Traditional while in higher tax brackets (especially if your future tax bracket will be lower when you distribute the Traditional IRA).
• Roth IRA’s allow distributions prior to age 59 ½ without tax consequences, assuming you're withdrawing contributions (not earnings) and the account has been held for over five years.
• Always have a 6-12 month Safety Fund before contributing to retirement plans (this eliminates needing to take early distributions should financial trouble hit)
• In addition to a Safety Fund, it’s advisable to plan for unexpected expenses (car maintenance, house repairs, etc.) so you can access penalty-free cash at drop of hat for job loss, health problems, etc.

 
We recommend contributing to a Roth every year that you possibly can! We say this because we see a lot of folks in retirement with all of their money coming from taxable sources (pensions, 401k distributions, rental properties, dividends/interest, etc.). It’s nice to have some non-taxable retirement money to access!

Updated 1/22/2024