You have probably heard of a variety of accounts commonly used for retirement savings. But how do you keep the different types straight and decide which is right for you?

Read on for a guide to three of the most commonly used retirement accounts.

What is a Roth IRA?

Roth IRAs, or individual retirement accounts, were established by the Taxpayer Relief Act of 1997. These accounts are funded with after-tax dollars, which means you can make qualified distributions tax-free (e.g., for distributions made before you turn 59 and a half, earnings are taxed at 10%).

Unlike employer-sponsored retirement plans, a Roth IRA enables you to maintain the same account even if you change jobs. You can choose your preferred financial institution to oversee your Roth IRA, select investments (if available) and determine annual contributions to the account within the limits set by the IRS.

What is a Traditional IRA?

A traditional IRA, or individual retirement account, is also a personal savings account, as opposed to an employer-sponsored retirement account. However, these accounts are funded with pre-tax dollars, which means you are not taxed until you withdraw the funds.

What is a Roth 401(k)?  

Established under the Economic Growth and Tax Relief Reconciliation Act of 2001, Roth 401(k)s are employer-sponsored accounts that combine the features of traditional 401(k)s and Roth IRAs. Similar to traditional 401(k)s, contributions are deducted directly from an employee’s earnings and employers may provide matching contributions. However, what sets Roth 401(k) plans apart from their traditional counterparts is that income taxes are deducted from the contributed funds before they enter the account. That means qualified distributions from a Roth 401(k), like qualified distributions from a Roth IRA, are tax-free.

What are the differences between these accounts?

The biggest difference between traditional retirement accounts and Roth retirement accounts is that traditional IRAs and 401(k)s are funded with pre-tax dollars and Roth accounts are funded with after-tax dollars. This means that with Roth accounts, taxes are deducted from the contributed funds before they enter the account and qualified distributions are mostly tax-free.

The more complicated breakdown is comparing Roth IRAs and Roth 401(k)s. Roth IRAs are individual and not employer-sponsored accounts, while Roth 401(k)s are employer-sponsored accounts. That means that if you have a Roth 401(k), your employer might match your contributions, which is a big benefit. There are other differences, too, though.  

A Roth 401(k) has higher contribution limits than a Roth IRA, and the contribution limits vary slightly depending on the year and your age.

* These are aggregate limits for all Roth 401(k) plans and traditional pre-tax employer plans.
** These are aggregate limits for all your traditional IRAs and Roth IRAs.

In addition to higher contribution limits and the benefit of employee-matched funds, Roth 401(k)s have no income limits. That means you can contribute to a Roth 401(k), regardless of your income. Only certain tax filers making less than $138,000 in 2023, or $218,000 for married filings jointly couples (and qualifying widow(er)), can contribute the full amount to a Roth IRA. For Roth IRAs, there are also higher income levels if you want to contribute a reduced amount.

Three benefits of a Roth IRA compared with a Roth 401(k) are: (1) the Roth IRA is not tied to any particular employer and can stay with you over the long term, (2) there are no required distributions with a Roth IRA, and (3) the Roth IRA allows investors more control over their accounts than a Roth 401(k). With a Roth IRA, you can choose from a wide variety of investments (if available), whereas in a 401(k) plan you’re limited to the funds your employer plan offers.

Which account type is right for you?

Most financial advisors would recommend you invest in a Roth 401(k) if you have the opportunity through your employer. If you max out your Roth 401(k) and pre-tax contributions, and you have extra money to put away toward retirement, you can also open a Roth IRA and contribute to that to maximize the additional flexibility and investment opportunities.  

If you don’t have access to a Roth 401(k), a Roth IRA is a good option. Either way, if you avoid making early withdrawals (i.e., before 5 years from the date of contribution and before you turn 59 and a half), you should be able to take money out tax-free during retirement.

While this guide addresses the different accounts in broad strokes, it’s always best to discuss your savings and retirement options with a financial advisor who can provide guidance based on your situation.

Talk to an advisor

To discuss which accounts are the best fit for you, contact Osaic Institutions at Bellco Credit Union. Learn more about the services or talk to an advisor today.