A Roth Ira is a self-directed retirement account and 401k is an employee sponsored retirement account. These are two ways to invest for your retirement. These accounts are tax advantaged investment accounts that the government has created for us. Thanks to these accounts people can save more money while investing for retirement and make way more money than if they had put it into a normal brokerage account.
This is the account that you can open by yourself. This is the most important benefit of having a Roth Ira and the biggest difference between Roth Ira and 401K. You do not have to work for a company. This is an opportunity for self-employed people.
Benefits of Having a Roth Ira Account
With the Roth Ira you are investing post tax money therefore you do not have to pay any taxes for your profit. Roth Ira is just a vehicle to help your money grow tax free. You can invest whatever you want with Roth Ira. There is a $6000 contribution limit for each year. The Roth Ira account allows you to pay no taxes on the profit. Normally when you invest money in the stock market to make a profit you must pay taxes for that profit.
For instance, let us say you put in $10,000 into your brokerage account in two stocks then that money grows to $30,000. It means that you made a good profit of $20,000. If you take that money out of your account, you must pay taxes for that $20,000. However, with the Roth Ira, you do not have to pay taxes for that $20,000. It does not matter what the tax brackets are in the future because this after-tax money already and whatever it grows to is yours. The other benefit is that any time you can take out your profit if you want to.
You can take out your contributions but cannot take out your gains. It means you are not supposed to touch the money in your Roth Ira accounts until you are 60. But there are some special circumstances where you can take out your money. And another benefit of having a Roth Ira account is that once to put your money into that account, you can use that money to buy anything you want such as mutual funds or individual stocks. Think of it as a vehicle therefore you can invest it in other things.
It is a retirement account that employers offer therefore you will have to work for a company or with someone. If you are a full-time worker for a company, you are likely to get a 401K account. It is more automated than the Roth Ira account and it is a good way for people to save money for retirement. It is pre-tax income. You are investing pre-tax money with 401(k). When you take the money out of that account, you are going to pay taxes. You must have a company to set this account for you.
There is no income limit for 401K unlike Roth Ira. However, if you are under the age of 50, the contribution limit is $19,000 per year. For instance, you are a person who gets a $50,000 salary and you invest $7,000 into your 401K account. The $7000 is pretax income therefore that reduces your taxable income by $7000.
The profit for a 401(k) will be taxed later on when you’ll take that money out of your account. The disadvantage of having a 401(k) account is profit tax and it is limited compared to a Roth Ira. You cannot open this account by yourself so setting up this account is harder than setting up a Roth Ira account.