Which plan is the better choice? They are both great retirement tools. They work differently and the better choice depends on many factors. Mainly it comes down to your income, tax situation and personal goals. Here are some important facts about both to help you decide:
401K
Contributions are made with pre-tax income. In other words, it is taken out of your pay check before you pay taxes. You pay taxes when you withdraw the money and hopefully it will be in a lower tax bracket.
Pros
- Reduces taxable income that you make today
- Employer usually matches up to a certain percent which is free money.
- Forces you to save for retirement with automatic payroll deductions
- Most employers allow you to take out a loan on 401k
- Great if you believe your tax rate will be low in retirement
Cons
- Limited investment choices
- Taxes are due upon withdrawals
- Early withdrawals usually are penalized
- Under federal tax law, most 401(k) owners must start taking withdrawals by age 72 (these are called required minimum distributions, or RMDs).
Roth IRA
Pros
- You pay taxes on contributions now but your earnings and withdrawals in retirement are completely tax-free. (Have to be 59.5 and have had the account for 5 years)
- There is no minimum distribution. You can grow your tax-free for as long as you live
- Flexible withdrawals
- You can pass your Roth IRA to your heirs tax-free
- You can contribute in retirement with earned income
- Great if you believe your tax rate will be higher in retirement.
Cons
- No loans are allowed
- Contribution limits are lower – in 2025 you can only contribute 7000 per year and $8000 if you are 50+
- No employer matches
- No immediate tax deduction
- Income limits (ask your advisor)
As you can see there are many factors that will enable you to make a wise decision. Seek further advise from your financial advisor.
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