What's the Difference Between a 401k and Roth IRA?

Brielle Mauder

What are investment accounts?

The term 'investment' can be defined as contributing money, time, or resources to a particular thing, project, person in this present moment, with the hopes of benefitting from it in the future.

For example, you could say that you're 'investing in your future' when you spend an hour of your time every day playing the guitar because of the long-term benefit of becoming a guitarist in the future. You're contributing now to reap the rewards in the future.

In the money world, an investment looks like contributing money towards an account that holds stocks, bonds, ETF's, etc. If you manage your money right, you can be set financially by the time you retire (averaging 59-60 years old). Cool! So where do I start?

Check out the quick overview below between two different types of investment accounts: a 401k and a Roth IRA.

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What do their names stand for?

401k is named after section 401(k) of the Internal Revenue Code put out by the Internal Revenue Service (IRS).

A Roth IRA stands for Individual Retirement Accounts and was created by Senator William Roth (that's why it's nicknamed 'Roth' IRA).

Though these accounts have different tax advantages and rules, they both still fall under the 'investments' category.

How much money can I add to my account each year?

For your 401k, you can contribute up to $19,500 per year.

For your Roth IRA, you can contribute up to $6,000 per year.

Note that this amount will vary slightly depending on your marital and working status as a household.

Are there any limitations?

For your 401k, there are no income limitations but this type of investment account is only available through an employer.

A Roth IRA is available to any individual, but income restrictions do apply.

What about matching?

When utilizing a 401k, an employer will often offer to pay a small percentage of your salary in addition to what you contribute to your own account. This will vary, but typically the percentage range is 1% - 8%.

When utilizing a Roth IRA, there is no employer match or contribution made as it is an independent, personal investment account that is not reliant on the employer.

Are there any upfront taxes?

When you contribute to your 401k, it is taken automatically out of your paycheck and is not taxed (pre-tax money). The benefit is that you don't pay taxes now, but will need to once you withdraw.

When contributing to your Roth IRA, you can only add taxed money into this type of account. The benefit is that you pay taxes now and get it out of the way so that when you withdraw, all the money in there is yours.

What can I invest in within each of these accounts?

In a 401k, you're limited in what you can choose from in terms of investments. Your employer hires a retirement company to manage the funds of their employees, and that retirement company comes to an agreement on a specific number of funds to invest in. Every so often, the retirement company, or your employer, may change up the selection. Overall, you don't have much control over what you can opt for and opt out of.

With a Roth IRA, you have a wider variety of choices and complete control over how you invest. The only downside with this is that you will need to do your own research and make decisions on when and in what way to invest in something. Take your time! There's no rush! A skill like this is not built overnight.

What happens when I withdraw my money?

When withdrawing from your 401k, your money will be taxed as regular income.

With an Roth IRA, you will not be taxed when you withdraw because you already paid taxes on the money you contributed.

Congrats! You just learned the basics of a 401k & Roth IRA!

Want to learn more or have questions? Check out our other blog posts or reach out. We'd love to help!

About the Author

Brielle Mauder is a contributor to The Adulting Manual. When she's not adulting, she enjoys snowboarding and playing with her fur-baby, Sophia. She and Tom are currently in the process of converting a van into a house so they can travel the world.