Questions like this are difficult to answer in an article since not all situations apply to all people. There is no “one-size-fits-all” financial plan when it comes to choosing a retirement account. Each type of retirement account has its own advantages and disadvantages, which makes one suitable for one investors but not for another.
That being said, there are some general guidelines you can use to help you figure it out. The first thing to consider is that neither Roth IRA’s or 401(k)’s are totally tax free. There are tax implications with both types of accounts, the difference is when you pay those taxes.
With a Roth IRA you pay the taxes on your contributions upfront, so that the money you invest has already been taxed. That investment can then grow over time on a tax-free basis, and your subsequent withdrawals, including earnings that have been in the account for a certain minimum amount of time are tax-free.
401(k)’s, on the other hand, work exactly opposite from Roth IRA’s. You contributions are made with money that has not been taxed and will also grow tax-free, until you make a withdrawal. Once money is taken out of the 401(k), you pay taxes on both the contributions you made and the earnings, usually at the same tax rate you currently pay for income taxes.
Roth IRA’s do have a distinct advantage over the 401(k) in that you are not required to take withdrawals by a certain age. With a 401(k), you have to start taking distributions by the age of 70 ½ or there are penalties. This feature of a Roth IRA makes it a great way to leave money to your heirs if you are fortunate enough to not need it to survive.
Most people will need income from their retirement accounts in order to live, so you still need to make a decision. The question you need to ask yourself is whether you believe that your tax rate will be higher or lower when you retire? If you think your tax rates will be higher, then a Roth IRA makes sense. You will pay the taxes now, ensuring you pay the current tax rate.
But, if you feel that you will be living more simply in retirement and not making much in the way of income, there is always the chance your tax rate will be lower in the future. If that’s the case, then a 401(k) is a good option for you.