A growing number of people have access to Roth 401(k)s at work — and that’s good, because Roths can be a great way to save. The question is, which is best for you: a Roth 401(k) or a Roth IRA?
It’s a choice many savers face: 70% of medium-sized and large companies now offer a Roth 401(k), up from 46% in 2012, according to consulting firm Willis Towers Watson. And anyone can open a Roth IRA if they fall within the income limits set by the IRS.
Both types of Roth accounts offer the same valuable benefit: Your investments grow tax-free.
Both types of Roths offer the same valuable benefit: Your investments grow tax-free. As long as you follow the rules, all of your money comes out tax-free in retirement. You can’t really go wrong with either type of Roth.
But there are a handful of ways in which the two accounts differ. Depending on your situation, a Roth 401(k) may be better for you than a Roth IRA, or vice versa.
We’ve created a chart for you to compare Roth 401(k)s and Roth IRAs. But first, take these two steps:
1. Get the match
If your employer offers a company match in your 401(k), contribute enough to the 401(k) to qualify for that free money. Because … free money.
2. Check investment fees
A hugely important savings strategy is to find low-cost investments. A NerdWallet study found that a 1% fee could cost a millennial $590,000 in savings over their lifetime. Now, 401(k) plans vary widely, and the investments offered in your plan may be amazing — or awful. You’ll need to look at your 401(k) to see if it offers diversified and low-cost investments. (As a general rule, a mutual fund with an expense ratio of 1% or more is too expensive; ideally you’re paying less than 0.5%.)
The key question when deciding between a Roth IRA or Roth 401(k) is, “Where can I get the least expensive investments?” says Michael Weddell, a senior consultant at Willis Towers Watson, where he works with companies on their workplace retirement plans.
Generally, large companies have lower-cost 401(k) investment options than smaller companies, Weddell says, thanks to economies of scale. But, he says, “there’s no substitute for actually looking it up and comparing the expense ratios of the funds.”
Here’s what to do:
- If your 401(k) investments are pricey, contribute just enough to get the company match, and then proceed directly to a brokerage to open a Roth IRA. (We reviewed the major brokers — see our top IRA picks.)
- If your 401(k) offers low-cost mutual funds, then you’re ready to check out our chart to decide whether the Roth IRA or Roth 401(k) makes the most sense for you. Or, if you’re ready to maximize your retirement savings, go ahead and contribute to both.
Want to take action?
Use our calculator to see how much you should be saving in your 401(k)
Want to dive deeper?
Read more about how and where to open a Roth IRA
Want to explore related?
Find out how to pick a handful of mutual funds when investing for retirement
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