Difference between Roth IRA and 401K: It would be helpful to know the difference between Roth IRA and 401k if you are shopping for an ideal retirement plan. They are just two of the various plan options available in the market.
They both promise a good investment for the future. Whether you are working in a company or self-employed, you will need to check out these retirement plans.
What is Roth IRA
Roth IRA is a personally-instituted plan. This is so because you purchase it and pay for it out-of-pocket. Roth IRA uses after-tax money for your retirement savings.
With Roth IRA, the investment growth remains untaxed until withdrawal. Being privately purchased, you can apply for this kind of plan alongside any other plan such as 401k.
If you are less than 50 years old, Roth IRA allows a maximum annual contribution of up to $5,500. If you are 50 years old and above, you may add $1,000 to your annual contributions.
But, you will not qualify for Roth IRA if you have an annual income of more than $114,000 (or $191,000 for couples).
What is 401k
401k plan is named in reference to the section of the Internal Revenue Code that outlines it. This is a retirement plan offered by for-profit companies and organizations. This is an ideal plan if you belong to the high income tax bracket.
The obvious difference between Roth IRA and 401k is that a 401k plan is generally sponsored by your employer as opposed to the privately-purchased Roth IRA.
With 401k, you can choose up to how much of your paycheck you would like to be contributed to the plan. Also, 401k is a pre-tax retirement plan.
Your contributions are taken before your paycheck is taxed. In this case, taxes are deferred until the day you actually withdraw money from your retirement fund.
As with Roth IRA, the investment growth will also remain un-taxed until withdrawal.
On the other hand, with a 401k retirement plan, you are allowed to set aside a pre-tax amount of up to $17,500 per year from your paycheck to build up your retirement fund or savings.
This applies if you are still under 50 years old. For those who are 50 years old and above, they are allowed “catch-up” contributions of $5,500 up to a total of $23,000.
Difference between Roth IRA and 401K
Another notable difference between both are on the way your contributions are being taxed. Roth IRA contributions and qualified distributions are not taxed.
Keep in mind however that non-qualified distributions may incur a penalty upon withdrawal. Meanwhile, with a 401k plan, the IRS will not tax the investment gains within the duration of the plan.
In this case, your contributions will only be taxed the moment you reach your retirement age and when you begin to withdraw money from your savings.