I Absolutely Prefer a Roth IRA to a Roth 401(k) for Retirement Savings. Here's Why.

Unless you're independently wealthy, you need to be saving and investing for retirement. It's a major undertaking, to be sure, but there's a wide variety of retirement savings accounts that can help you.

Two of the most commonly used ones are the IRA and the 401(k), and each of those exists in both a traditional and a Roth form. You can open IRA accounts at most good brokerages, while 401(k) accounts are set up at workplaces. Different investors may have different favorite accounts, but my favorite is the Roth IRA. Here's a look at why.

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Major retirement savings accounts

Commonly used retirement accounts include IRAs, 401(k)s, 403(b)s, 457s, solo 401(k)s, SEP IRAs, SIMPLE IRAs, and Keogh plans. SEP-IRAs, solo 401(k)s, and SIMPLE IRAs are particularly worth considering if you're self-employed. If you have an employer, you may have other kinds of accounts available to you.

With a traditional IRA or a traditional 401(k), you get an upfront tax break; the amount you contribute for a certain tax year can be deducted from your taxable income for that year. So if you contribute $7,000 this year, your taxable earnings drop by $7,000, shrinking your tax bill.

With a Roth IRA or Roth 401(k), your contributions are made on a post-tax basis. There's no upfront tax break, but if you follow the rules, you can eventually withdraw money from your Roth account tax free! Those who save and invest in these accounts can amass hundreds of thousands of dollars in them -- and in some cases, millions of dollars. Being able to withdraw all that money in retirement tax free can be a big, helpful deal.

Pros and cons of IRAs and 401(k)s

Here's a brief review of the main pros and cons of IRAs and 401(k)s, which will shed light on why I favor Roth IRAs.

Pros of IRAs

• Much wider investment menu. While 401(k) accounts typically offer you a limited menu of investments to choose from (ideally including at least an S&P 500 index fund). You can invest in just about any stocks in your IRA, plus, typically, gobs of mutual funds and exchange-traded funds (ETFs).
• Available to most people. To participate in a 401(k), you need an employer that offers one. But anyone with earned income can contribute to an IRA. Even spouses without earned income can contribute.

Pros of 401(k)s

• Much bigger contribution limits. For 2024, the limit is $23,000, plus an additional $7,500 "catch-up" contribution for those 50 or older, bringing the total to $30,500.
• Employer matches. Many employers offer matching contributions to employees' 401(k) contributions. A common formula is to match 50% of contributions, up to 6% of salary. So if you earn $100,000 and contribute $6,000, your employer will chip in another $3,000 -- of free money.
• Your ability to participate is not income-limited.
• Contributions are generally made by automatic payroll deductions.
• Roth 401(k)s are not always available.
• Many 401(k) plans permit borrowing from your account although that's generally inadvisable.

Cons of IRAs

• Smaller contribution limits. For 2024, you can contribute $7,000 to an IRA, plus $1,000 if you're 50 or older, for a total of $8,000.
• No employer matching contributions.
• Eligibility to contribute to Roth IRAs is phased out at high-income levels.
• Ability to claim deductions for traditional IRA contributions is phased out for some at higher-income levels.
• Required minimum distributions (RMDs). RMDs are mandated for traditional IRAs, beginning at age 73 and increasing to age 75 in 2033.
• IRAs are not always great for investing novices.

Cons of 401(k)s

• Limited menu of investments from which to choose.
• Little control over fees charged by various investments.
• Required minimum distributions (RMDs): RMDs are mandated for traditional 401(k)s, beginning at age 73 and increasing to age 75 in 2033.

What's best for me -- or you

You may now be able to guess why I love Roth IRAs. I love having the freedom to invest in any stocks or ETFs I want, including growth stocks and dividend-paying stocks. (And for those who don't want to pick, it's easy to invest in a simple, low-fee index fund in an IRA, too.) With a Roth IRA, I can look forward to tax-free withdrawals in retirement, and I won't be forced to take RMDs at certain times, giving me more control over the account.

Of course, a different account might be more perfect for you. And all of us should understand that we can usually save for retirement in multiple accounts. I used to have an IRA and a 401(k), but when I became a contractor, I converted my 401(k) into an IRA. I now have multiple IRA accounts, both traditional and Roth.

Ideally, strategize about how to save and invest for retirement. If you favor IRAs, you might still contribute enough to a 401(k) to at least max out your company match. Then you might max out your IRA contribution, after which you can start contributing to your 401(k) again. Or crunch the numbers and contribute concurrently to all your accounts in the appropriate amounts.

Above all, be sure to have a good retirement plan, and if that intimidates you, consider consulting a financial advisor.

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