If you're already contributing to your employer's 401(k), you may be under the impression that you've checked off the retirement-saving box from your financial to-dos.
And while you rightfully deserve kudos for making that effort, you also want to keep building your retirement fund (if you can afford to). Matching a 401(k) with a Roth IRA allows you to diversify your savings while also getting exposed to different tax advantages and withdrawal options.
Below, CNBC Select breaks down the differences between these two retirement-saving vehicles and explains why it can be most effective to have both.
Differences between 401(k) and Roth IRA
A 401(k) and a Roth IRA have significant differences in how you can benefit from each account. Here's what should be top of mind:
How you qualify
For starters, you need an employer to offer a 401(k) plan in order to have one, while you can open and establish a Roth IRA on your own without an employer's involvement as long as your income qualifies. Though there are income limits that come with Roth IRAs, high-earners can revert to a loophole to make contributions indirectly through what's called a backdoor Roth IRA.
Some of the best Roth IRA options are offered by the big-name brokerages like Charles Schwab, Fidelity, Ally Bank and robo-advisors Wealthfront and Betterment.
Charles Schwab
Minimum deposit and balance
Minimum deposit and balance requirements may vary depending on the investment vehicle selected. No account minimum for active investing through Schwab One® Brokerage Account. Automated investing through Schwab Intelligent Portfolios® requires a $5,000 minimum deposit
Fees
Fees may vary depending on the investment vehicle selected. Schwab One® Brokerage Account has no account fees, $0 commission fees for stock and ETF trades, $0 transaction fees for over 4,000 mutual funds and a $0.65 fee per options contract
Bonus
None
Investment vehicles
Robo-advisor: Schwab Intelligent Portfolios® and Schwab Intelligent Portfolios Premium™ IRA: Charles Schwab Traditional, Roth, Rollover, Inherited and Custodial IRAs; plus, a Personal Choice Retirement Account® (PCRA) Brokerage and trading: Schwab One® Brokerage Account, Brokerage Account + Specialized Platforms and Support for Trading, Schwab Global Account™ and Schwab Organization Account
Investment options
Stocks, bonds, mutual funds, CDs and ETFs
Educational resources
Extensive retirement planning tools
Terms apply.
Betterment
Minimum deposit and balance
Minimum deposit and balance requirements may vary depending on the investment vehicle selected. For example, Betterment doesn't require clients to maintain a minimum investment account balance, but there is a ACH deposit minimum of $10. Premium Investing requires a $100,000 minimum balance.
Fees
Fees may vary depending on the investment vehicle selected, account balances, etc. Click here for details.
Investment vehicles
Robo-advisor: Betterment Digital Investing IRA: Betterment Traditional, Roth and SEP IRAs 401(k): Betterment 401(k) for employers
Investment options
Stocks, bonds, ETFs and cash
Educational resources
Betterment offers retirement and other education materials
Terms apply. Does not apply to crypto asset portfolios.
The tax advantages
Although both a traditional 401(k) and a Roth IRA offer tax breaks, they come at different times. With a 401(k), your contributions get automatically deducted from each paycheck and are not taxed; tax is deferred, meaning your contributions into your 401(k) account are made with pre-tax dollars and you don't pay taxes until you withdraw. With a Roth IRA, however, you pay taxes upfront with each contribution so withdrawals later on are tax-free.
In addition to offering you the traditional 401(k), your employer may also give you the choice of a Roth 401(k). Your contributions to a Roth 401(k) are taxed, but your distributions are tax-free (similar to a Roth IRA).
Withdrawal rules
It's important to point out that you can withdraw your contributions from a Roth IRA at any time without paying tax or penalties. (Withdrawing any earnings you've made on your investments in a Roth IRA before age 59 and a half, however, will incur a 10% early withdrawal penalty and may be subject to income taxes; there are some qualifying exceptions). With a 401(k), any early withdrawals before age 59.5 will typically force you to pay penalties and taxes, though there are also hardship exceptions.
How much you can contribute
Lastly, a 401(k) and a Roth IRA have different annual contribution limits. For 2023, the 401(k) limit is $22,500, or $30,000 if you're age 50 or older, and the total IRA limit is $6,500, or $7,500 if you're age 50 or older.
Why contribute to both 401(k) and Roth IRA
If you can afford to fund two retirement accounts simultaneously, having both a 401(k) and a Roth IRA helps you maximize your retirement-saving options since they offer opposite tax benefits. You get an immediate tax break with a 401(k) and with a Roth IRA you're essentially guaranteed a tax break in the future. This setup takes some of the pressure off of having to guess whether you'll be in a lower or higher tax bracket during your retirement years since you'll have a retirement account that suits each scenario.
"A lot of the time it's unknown," Mindy Yu, a Certified Investment Management Analyst (CIMA) and director of investing at Betterment, tells CNBC Select. "So that's why having access to both a 401(k) plus a Roth IRA is beneficial because it's a way of spreading your tax liability and tax diversification because you don't know what outcome or tax bracket you'll be in the future."
And although both retirement accounts have contribution limits, a Roth IRA's maximum contribution is considerably lower than a 401(k)'s so you're restricting yourself in how much you can save if you just have a Roth IRA. On the other hand, with just a 401(k), you're really best off not touching your funds before retirement; add in a Roth IRA, however, and you have a bit more leeway if for some reason you need access to your contributions early on.
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How much to contribute to 401(k) and Roth IRA
If you have both a 401(k) account and a Roth IRA, you now need to decide how much to put into each account. It's generally advised to max out your retirement accounts, but we realize that's not something everyone can afford to do.
Try to prioritize contributing as much to your 401(k) as you need to meet an employer match, if your company offers one. For example, if your company matches up to 6% of your salary, contribute 6% so that you're doubling what you can save for retirement.
To figure out how much to contribute to your Roth IRA, start with the rule of thumb that you should put 10% to 15% of your pre-tax (gross) income each year — including your employer's match — into all of your retirement savings accounts. Using the example above, if you contribute 6% of your pre-tax income to your 401(k) and your employer matches that with another 6%, that means you're already putting 12% of your pre-tax income toward retirement. You can then contribute the remaining 3% of your pre-tax income (to reach the upper-end 15% from the rule of thumb) into your Roth IRA.
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Bottom line
The best way to maximize your retirement savings is to diversify how you grow that nest egg. Adding a Roth IRA along with your employer-sponsored traditional 401(k) gives you the opportunity to take advantage of different tax benefits, withdrawal rules and contribution limits.
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