Table of Contents
One of the most common questions in personal finance is: "Should I invest in my 401(k) or a Roth IRA first?" The answer depends on your income, tax situation, and employer benefits. This guide will help you make the right decision for your circumstances.
401(k) vs Roth IRA: Key Differences
Traditional 401(k)
- Tax treatment: Pre-tax contributions, taxed on withdrawal
- Contribution limit (2024): $23,000 ($30,500 if 50+)
- Employer match: Often available (free money!)
- Income limits: None
- Withdrawal rules: Penalty before age 59½ (with exceptions)
- Required distributions: Start at age 73
Roth IRA
- Tax treatment: After-tax contributions, tax-free withdrawal
- Contribution limit (2024): $7,000 ($8,000 if 50+)
- Employer match: Not available
- Income limits: Phases out at $146K-$161K (single), $230K-$240K (married)
- Withdrawal rules: Contributions can be withdrawn anytime
- Required distributions: None for original owner
2024 Contribution Limits
| Account | Under 50 | 50 and Over |
|---|---|---|
| 401(k) | $23,000 | $30,500 |
| Roth IRA | $7,000 | $8,000 |
| Combined Maximum | $30,000 | $38,500 |
The Priority Order: Where to Invest First
1. 401(k) up to Employer Match
This is free money with an immediate 50-100% return. Never leave employer matching on the table.
2. Roth IRA (if eligible)
Tax-free growth, flexible withdrawals, and no required distributions make this a powerful account.
3. Max Out 401(k)
Return to your 401(k) to max out the $23,000 limit. Tax benefits and high contribution limits make this valuable.
4. Taxable Brokerage Account
After maxing retirement accounts, invest in a regular brokerage for additional flexibility.
Tax Analysis: Traditional vs Roth
Choose Traditional 401(k) If:
- You're in a high tax bracket now
- You expect to be in a lower tax bracket in retirement
- You need the tax deduction to reduce current taxable income
- You want to reduce your adjusted gross income (AGI) for other tax benefits
Choose Roth IRA (or Roth 401(k)) If:
- You're in a low tax bracket now
- You expect to be in a higher tax bracket in retirement
- You want tax diversification in retirement
- You want flexibility to withdraw contributions
- You want to avoid required minimum distributions
💡 The Tax Diversification Strategy
Many experts recommend having both traditional and Roth accounts. This gives you flexibility in retirement to choose which account to withdraw from based on your tax situation each year.
Real-World Scenarios
Scenario 1: New Graduate, Low Income ($45K)
Strategy: Roth IRA first, then 401(k) match
- Contribute $500/month to Roth IRA ($6,000/year)
- Contribute enough to 401(k) to get full employer match
- Why: Low current tax rate makes Roth attractive
Scenario 2: Mid-Career, High Income ($120K)
Strategy: Max 401(k), then backdoor Roth IRA
- Max out 401(k) at $23,000
- Use backdoor Roth IRA strategy ($7,000)
- Why: High tax rate makes traditional 401(k) valuable
Scenario 3: Near Retirement, Peak Earnings ($200K)
Strategy: Max traditional 401(k), catch-up contributions
- Max 401(k) with catch-up: $30,500
- Consider Roth conversions in lower-income retirement years
- Why: Maximize tax deductions in peak earning years
Special Considerations
Roth 401(k) Option
Many employers now offer Roth 401(k) options. This combines the high contribution limits of a 401(k) with the tax-free growth of a Roth IRA. Consider this if:
- You want tax-free growth
- You earn too much for a Roth IRA
- You expect higher taxes in retirement
Backdoor Roth IRA
If you earn too much for a direct Roth IRA contribution, the backdoor Roth IRA strategy allows you to contribute indirectly:
- Contribute to a traditional IRA (non-deductible)
- Convert to Roth IRA immediately
- Pay minimal taxes on any growth
⚠️ Important Rules
- 401(k) contributions must be made by December 31
- IRA contributions can be made until tax day (April 15)
- Early withdrawals from 401(k) face 10% penalty (with exceptions)
- Roth IRA contributions (not earnings) can be withdrawn anytime
Bottom Line
At minimum, always contribute enough to your 401(k) to get the full employer match—it's free money. Beyond that, the choice between 401(k) and Roth IRA depends on your current tax rate, expected future tax rate, and need for flexibility. When in doubt, diversify: contribute to both.