Invest in a Roth IRA or 401K?

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.

Should You Invest in a Roth IRA or 401K?

The 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?”.

Roth IRA vs 401K

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 IRAs first – either a Roth IRA or a Traditional IRA (Roth IRAs have a buzz about them, but don’t overlook Traditional IRAs). 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 ($23,000 in 2024) 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 IRAs and 401Ks 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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