What Are the Differences Between a 401k and a Roth IRA?

For many Americans, the 401(k) and the Roth Individual Retirement Arrangement (IRA) are the primary vehicles for saving for retirement. While both accounts are designed to help you build wealth, they operate under different rules. Understanding the distinct characteristics of each is important for developing a retirement strategy that aligns with your personal financial circumstances and future goals.

Tax Treatment of Contributions

The most significant distinction between a traditional 401(k) and a Roth IRA is how contributions are taxed. A traditional 401(k) is funded with pre-tax dollars, meaning contributions are deducted from your paycheck before income taxes are calculated. This reduces your current taxable income for the year. For example, if you earn $60,000 and contribute $5,000 to a traditional 401(k), you will only be taxed on $55,000 of income for that year.

Conversely, a Roth IRA is funded with post-tax dollars, meaning you contribute money that has already been subjected to income tax. There is no upfront tax deduction for putting money into a Roth IRA. Using the same scenario, if you earn $60,000 and contribute $5,000 to a Roth IRA, your taxable income for the year remains $60,000.

The choice between pre-tax and post-tax contributions depends on an individual’s expectation of their future financial situation. A person who believes they will be in a higher tax bracket during retirement might prefer the Roth IRA, paying taxes now to secure tax-free withdrawals later. Someone who anticipates being in a lower tax bracket in retirement may opt for the traditional 401(k) to benefit from the tax deduction during their higher-earning years.

Many employers now offer a Roth 401(k) option. This hybrid account allows for post-tax contributions like a Roth IRA but within an employer-sponsored plan structure. This option provides flexibility for employees who want the tax-free withdrawal benefits of a Roth account but also wish to contribute at the higher 401(k) limits. Your combined contributions to traditional and Roth 401(k)s cannot exceed the annual limit.

Contribution Limits and Income Eligibility

The rules governing how much money can be placed into these accounts each year differ. For 2025, the contribution limit for a Roth IRA is $7,000 per year. Individuals aged 50 and over are permitted to make an additional “catch-up” contribution of $1,000, bringing their total possible contribution to $8,000 annually. These limits apply to the combined total of any traditional and Roth IRAs an individual holds.

The 401(k) plans allow for much higher contribution levels. For 2025, an employee can contribute up to $23,500 to their 401(k). The catch-up contribution for those aged 50 and over is $7,500, allowing eligible individuals to contribute a total of $31,000. A special provision for 2025 allows individuals aged 60 to 63 to make a higher catch-up contribution of $11,250, but employees should verify if their specific plan has adopted this option.

A defining feature of Roth IRAs is the income limitation on direct contributions. For 2025, the ability for single filers to contribute is reduced if their Modified Adjusted Gross Income (MAGI) is between $150,000 and $165,000 and is eliminated for those with a MAGI of $165,000 or more. For married couples filing jointly, this phase-out range is between $236,000 and $246,000. Traditional 401(k) plans do not have such income restrictions.

Employer Matching

A significant advantage of 401(k) plans is the potential for an employer match, where your employer contributes money to your retirement account. Employer matching is almost exclusively associated with 401(k)s, as IRAs do not offer this benefit. The structure of a match can vary, but a common formula is for the employer to contribute 50 cents for every dollar you save, up to a certain percentage of your salary.

Failing to contribute enough to receive the full employer match is often likened to turning down free money. This matching contribution can accelerate the growth of your retirement savings over time. Many financial advisors suggest contributing at least enough to your 401(k) to capture the entire employer match before directing funds to other retirement accounts.

It is important to understand the tax treatment of these matching funds. Even if you contribute to a Roth 401(k) with post-tax dollars, employer matching contributions are always made on a pre-tax basis. This means the matched funds are placed into a traditional pre-tax portion of your 401(k). Consequently, you will be required to pay income tax on the employer-matched funds in retirement.

Withdrawal Rules and Taxation in Retirement

The tax treatment of withdrawals in retirement is a mirror image of the contribution rules. For a traditional 401(k), all withdrawals are treated as ordinary income and taxed at your income tax rate at the time of withdrawal. This deferred taxation is the trade-off for receiving a tax deduction during your working years.

Roth IRAs operate in the opposite manner. Because contributions are made with money that has already been taxed, qualified withdrawals are completely tax-free, including both contributions and investment earnings. To be considered a “qualified withdrawal,” the account owner must be at least 59½ years old, and the account must have been open for at least five years.

Another difference emerges with Required Minimum Distributions (RMDs). The IRS mandates that individuals must begin taking annual withdrawals from their traditional 401(k)s starting at age 73 (or 75 for those born in 1960 or later). This rule ensures that the government can eventually collect taxes on the deferred funds. Roth IRAs are not subject to RMDs for the original owner. As of 2024, Roth 401(k)s are also no longer subject to RMDs during the account holder’s life.

Investment Options

The range of available investments is another point of divergence. A 401(k) is an employer-sponsored plan, and the investment choices are limited to a menu selected by the employer or plan administrator. This menu usually consists of a handful of mutual funds, such as stock funds, bond funds, and target-date funds, which automatically adjust their asset allocation as you approach retirement.

This limited selection restricts the ability of a more hands-on investor to build a highly customized portfolio. The fees associated with the funds in a 401(k) plan may also be higher than those available on the open market.

In contrast, an IRA offers a much broader universe of investment options. When you open an IRA at a brokerage firm, you can invest in almost any security the firm offers, including:

• Individual stocks
• Bonds
• Exchange-traded funds (ETFs)
• A vast array of mutual funds

This flexibility allows for greater control and customization of your retirement portfolio.