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Home » 401K, IRA's, Roth 401K, Roth IRA

Invest in a Roth IRA or 401K?

Last updated by on April 19, 2016

It may seem like common knowledge to some, but the question on whether one should invest in a Roth IRA or a 401K is BY FAR the most common question I get from young professionals starting to dig into their finances.

It’s a great question. And it’s important to get right because there are long-term financial implications.

Usually when people ask me this question, it starts a series of other questions.

So I will do my best to address the original question and some of the other common questions that follow. And I’m curious to see what other questions arise for you.

Roth IRA or 401K?

Roth IRA or 401KThe quick answer? It depends. When someone asks me this, I immediately follow-up with this question, “What kind of a 401K match does your employer offer?”.

In my 401K match post, I highlighted the following statistics from the National Compensation Survey:

  • 49% of employers with 401K plans match 0%
  • 41% match a percentage of employee contributions between 0-6% of salary.
  • 10% match a percentage of employee contributions at 6% or more of salary.
  • The median is a 3% match.

With those statistics in mind, there are two different ways to answer this question:

If your employer matches 0% of your 401K contribution…

Invest in IRA’s first – either a Roth IRA or a Traditional IRA (Roth IRA’s have a buzz about them, but don’t overlook Traditional IRA’s). Max them out. Then invest in your 401K.

Why? You’re not getting a match in your 401K, so there is no benefit to investing in it over an IRA other than the maximum 401K contribution being higher than the maximum IRA contribution. And you’ll have more investment options available to you in the IRA, which can mean lower fees for you. So max out your IRA contribution, THEN invest in your 401K for additional retirement savings and tax benefits.

If your employer matches your 401K contribution…

Invest in the 401K first in order to get the match. That is FREE MONEY that you will not get via IRA contributions. Invest in the 401K until you get the maximum employer match you can possibly get for the year, all the way up to the maximum personal 401K contribution level ($18,000 in 2016) if your employer matches that far. Then invest in your IRA. Once your IRA is maxed out, go back to the 401K.

Roth IRA vs. 401K Conclusion

That’s really as simply as I can answer the IRA vs 401K question.

Keep in mind that the maximum contributions for IRA’s and 401K’s are completely separate and independent of each other. This is not an ‘or’ choice. You can invest in both simultaneously, if you’d like. In fact, I’d encourage you to.

Also contributions to one don’t count against the other. One happens to be with your employer (401K) and the other does not (IRA).

Where Can I Get an IRA?

If you haven’t opened your IRA yet, check out my post on how to start an online broker account.

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About the Author
I am G.E. Miller, & this is my story. My goal is financial independence ASAP. If you share that goal, join me & 10,000+ others by getting FREE email updates. You can also explore every post I have written, in order.

  • I think another thing to consider is the difference in fees for funds. Typically, you will find lower cost funds in 401k accounts because of the buying power of the company. Also, there may be some funds that you can not invest in if you have an IRA because of fund minimums. Just a few other things to think about..

    • G.E. Miller says:

      I’ve actually seen the opposite. In a 401K, you’re limited to a small selection of funds, and usually not index funds or ETF’s (which have the lowest fees). Those funds often times have high expense ratios and there is nothing you can do about it. You’re limited in your lack of choice.

    • Julie says:

      Dave, isn’t the fund minimum thing temporary, though? That would only be an issue for the first year or two, if you contribute the max.

  • Julie says:

    I guess this question is really for those who cannot get a Roth 401k from their employers. I’m currently doing a bit of both a Roth and regular 401k, but not meeting the contribution limits yet. Once I do, I’ll open up an IRA as well.

  • Justin @ MoneyIsTheRoot says:

    I recently wrote an article on this topic as well, I included the traditional 401k as well…people make this more complicated than it needs to be. Definitely invest up to your employer match in a 401k since this is free money. Then if you have extra, invest in a roth IRA. If money is no object, then max out your 401k, then your roth ira, and then a traditional ira, and receive the maximum tax benefit.

  • Warren says:

    I’ve worked for several companies over the last 25 years and in most cases there was no annual fee, lower costs on the funds, a decent selection of funds, and matching. These were all companies that did matching, so I guess the more generous companies with matching were also more generous when setting up other aspects of the 401K. So it’s all in the details.

    People make the mistake of looking at the value of their 401K and IRA and trying to figure out what retirement will be like based upon that amount. They forget that taxes have not been paid. That’s where a Roth IRA is more straight forward in that what you see is what you get.

    Do the statistics about percentages of companies and what they match really tell the story. The larger companies I’ve worked for had the better matching and the smallest was the only company that had no match. So the 49% of companies with no match doesn’t necessarily represent 49% of the employees with a 401K.

    The company matching has become a replacement for the pension plans that many companies used to offer, so not putting in enough to take the full matching is really a matter of not taking the pension that the company is offering.

  • Chris says:

    With stocks that pay dividends… are those dividends able to be reinvested in the Roth without it counting towards the 5k limit?

    • Justin @ MoneyIsTheRoot says:

      Chris that is a good question…and the answer is no. Contribution limits are just that, contributions only.

      • Chris says:

        Also… say I open a Roth with a broker than put 5k in. Can I make as many trades as I want in that account as long as I don’t put in anymore money during the same year. Do I just put in another 5k the next year in the same account? So I might have like 12k over two years to trade as much as I want? I really don’t get how its set up exactly.

        What if I put in 5k in a Roth but don’t actually invest it. Say I put 5k in decemeber but don’t actually buy a stock until Jan. Can I still put another 5k in Jan So i have 10k to work with?

  • Mike says:

    Some 401k plans are junk. Until recently, the expenses on my 401k plans were over 1.00%. There is also no matching contribution. That’s why I put my cash into IRA’s. Not the Roth’s though. I believe the gov’t will eventually renege on their promise not to tax gains and place a modest tax on Roth gains in the future.

  • Ron Ablang says:

    I have a 457b w/ local gov’t and no match. I’m investing 31.5% of the yearly max ($16,500) and nothing to ROTH IRA (not since I got married anyway).

    I do this b/c the 457b contributions are pre-tax (so they lower my taxable income) and b/c it is invested before I have a chance to do anything like change my mind.

    I’ve always had a hard time manually contributing to my ROTH in the past.

  • Matt says:

    Assuming you won’t be able to hit the contribution limit and you have an average company match, are you better off focusing on your 401k due to the compounding interest potential?

    Won’t one larger sum reach a goal faster than two smaller sums?

  • engin33r says:

    In my opinion, I put a majority of my money into my 401k because our state taxes are very high here and I’m not sure I’ll still be in this state in retirement.

    The leftovers roll into my RothIRA because it’s still better to have something in a tax sheltered account vs on the open market (why pay taxes on your earnings when you don’t have to).

    I’ve also considered recently setting something up where my RothIRA can act as my emergency account but I’m not 100% sure if that’ll be a good idea (although the idea of a sizeable emergency fund sitting in a bank earning nothing sounds silly too).

  • mdenis39 says:

    I agree that you should max out on your employers 401k match, then consider whether Roth or traditional is the way to go. A few things to consider:
    1) Diversify your future tax liability by putting money in both a pre-tax (401k) fund & post-tax (Roth).
    2) While you are younger, making less money & therefore in a lower tax bracket, it makes sense to put more money into a Roth. Then as you move up in tax brackets (making more money), you can shelter some of that income from higher taxation by investing in pre-tax vehicles (401k & traditional IRA).
    3) Traditional IRAs & 401ks have a minimum withdrawal requirement – by age 70, you must take out a certain % of your funds every year. The Roth has no WD requirements. This flexibility could be important in tax planning at the time of withdrawal.
    4) Taxes are likely going up in the future, so in my opinion it makes sense to load your Roth IRAs now while taxes are relatively low.
    5) A new vehicle is a Roth 401k. My employer just started offering one in addition to the traditional 401k.
    6) I share Mike’s concern (above) that the fed gov’t could renege on its promise not to tax Roth IRAs. I think that there is a low probability that this would happen.

  • J Lane says:

    One aspect that should probably be cleared up, as if was left unclear and certain recommendations may have been made erroneously based on it: if you are actively contributing to a trad 401(k), your contributions to a traditional IRA are NOT tax-deductible. In such a way, it does become an “either/or” decision, not in terms of contribution limits but in terms of which one you want to act as your pre-tax vehicle. If you are actively contributing to a 401(k), your contributions to a traditional IRA are still tax-deferred but you do not have the benefit of higher interest compounding from pre-tax contributions on the frontend nor the Roth benefit of tax-free distributions on the backend. Absent employer matching, it becomes a decision of having greater selection of your funds and who is managing your money (potentially reducing your fees) with a lower max limit or having a higher max limit ($11,500 more) and paying more in fees with smaller fund selection, as mentioned above.

  • Tim says:

    Can I contribute the maximum to my Roth IRA (outside of work) and my 457 account (at work) or do I have to do one or the other?

  • onceandfuture says:

    I realize this is an old thread, but I have a related question. My employer won’t contribute to my TIAA CREF 401 3b until 1 year after my start date (Jan 7), but will then contribute 7% of my 31500 salary annually, no matching required. Should I start a Roth or traditional IRA (and which one of those two) while I wait for the one year mark to roll around? Should I continue to add to it after the 1 year waiting period or focus my efforts on the 4013b?

    Many thanks.


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