What’s The Difference Between A Roth IRA And A 401(k)?

Sometimes saving for retirement seems more complicated than it should be, and even more so when you work for yourself. There are a seemingly endless number of retirement accounts to choose from, and you want to make the best decision for your future (and for your family’s security).

As a self-employed real estate investor, we know you like to make smart money moves, and we’re committed to helping you make that happen. So let’s talk about two of the most common types of retirement savings plans: what’s the difference between Roth IRA and 401k?

What You Need To Know About Roth IRAs

Roth IRAs are a type of Individual Retirement Account (IRA), a retirement savings account you can use to invest in common securities such as stocks, bonds, certificates of deposit, and mutual funds. A traditional IRA allows you to contribute to your account with pre-tax moolah, but you’ll have to take required minimum distributions (RMDs) once you turn 72, and pay taxes on the money you receive.

With a Roth IRA, you pay your taxes up-front and then invest. Because Uncle Sam already got his cut, you won’t be required to take RMDs. You also don’t have to pay taxes when you choose to take distributions, as long as you’re older than age 59½, and you’ve had the Roth IRA for more than five years.

Roth IRAs are an exceptional choice if you’re self-employed or if your employer doesn’t offer a 401(k) plan. Even if you have a 401(k), you can use a Roth IRA to increase your retirement savings once you hit your 401(k) contribution limit.

Income and Contribution Limits

Unfortunately, the government puts income limits on who can invest in a Roth IRA and contribution limits on how much you can invest. 

If you’re married and file taxes jointly, you can’t use a Roth IRA if your combined modified adjusted gross income (MAGI) is $206,000 or higher. Roth IRAs are also unavailable if you’re single and your MAGI is $139,000 or more.

If you meet the income requirements, you can open a Roth IRA, but you can’t contribute more than $6,000 each year, or $7,000 if you are 50 or older.

Self-Directed Roth IRAs

A self-directed IRA (SDIRA) is a type of IRA that enables you to make investments that a regular IRA won’t allow. While IRAs can only accommodate common types of securities, an SDIRA can hold a much broader array of investment options.

Investments types available for SDIRAs but not regular IRAs include:

  • Real estate
  • Precious metals
  • Commodities
  • Private placements
  • Limited partnerships
  • Tax lien certificates
  • …. and more

An SDIRA is administered by a custodian or trustee, but you’ll manage the account directly. (That’s why they call it a “self-directed” account.) An SDIRA is available as either a traditional IRA or a Roth IRA and is an attractive choice for savvy real estate investors who want to use a tax-advantaged account.

What You Need To Know About 401(k)s

A 401(k) is a retirement savings plan that employers can offer, but there’s also a variation for you self-employed folks out there. As with a traditional IRA, a 401(k) allows you to invest pre-tax money in mutual funds, and then you’ll pay taxes on your distributions. 

401(k)s are usually funded through paycheck deductions from your gross pay. Many employers will also match contributions you make to your 401(k), which allows you to invest even more. You should always take advantage of an employer match if one’s available: it’s free money!

Contribution Limits

Like the Roth IRA, 401(k)s also have contribution restrictions. There are personal contribution limits and a total contribution limit for combined individual and employer contributions.

The annual 401(k) personal contribution limits for 2020 and 2021 are:

  • $19,500 if you’re younger than 50.
  • $26,000 if you are 50 plus.

The annual 401(k) total contribution limits for 2020 and 2021 are:

  • $57,000 in 2020 if you’re younger than 50.
  • $63,500 in 2020 if you are 50 plus.
  • $58,000 in 2021 if you’re younger than 50.
  • $64,500 in 2020 if you are 50 plus.

Solo 401(k)s

A Solo 401(k) is a 401(k) plan for self-employed people and their spouses. Solo 401(k)s follow the same rules as an ordinary 401(k) plan, but are only available to business owners with no employees. A significant advantage of the Solo 401(k) is that you can contribute to the account as both an “employee” and an “employer.” 

What Is The Difference Between Roth IRA And 401(k)?

When comparing Roth IRA vs. 401k, the main difference is the tax benefits offered. With a Roth account, you pay taxes now and then take tax-free distributions later in life. A 401(k)s allows you to contribute pre-tax money, reducing your taxable income and giving you a tax break now, but you’ll have to pay taxes when you take distributions.

The differences between Roth SDIRAs and Solo 401(k)s are even more apparent.

Roth SDIRAs allow you to invest in diverse types of assets, including real estate. Unfortunately, income and contribution limits can limit a Roth SDIRA’s effectiveness as an investment tool.

Solo 401(k)s are much more limited in the type of investments you can make, with your choices usually restricted to various mutual funds. However, you can invest much more money each year since you can contribute as both the employee AND the employer. 

Given the advantages and disadvantages of these retirement plans, your best course of action may just be to invest in both. There’s no rule that you can only pick one! You can even convert your IRA or 401(k) into a Roth account if you change your mind later. Creating a diverse retirement savings plan can help you maximize your investment opportunities and better prepare for your future.

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