IMPORTANT NOTE: See the section Roth IRA Conversions to learn about Roth IRA conversions that may be available to you even if you do not meet the criteria for a Roth IRA contribution.

Assuming you meet the requirements to set up a Roth IRA, how do you decide where to put your retirement savings each year?

With a 401(k), contributions are made with pre-tax assets, up to a maximum amount, and withdrawals are taxable. With a Roth IRA, contributions are made with after-tax assets, but withdrawals are not taxable once certain conditions are met. Thus, the best choice for you will depend on your tax situation.

A Roth IRA will generally be more beneficial for individuals who are far away from retirement and whose projected tax rate in retirement will be about the same or higher than it is now. It will also likely be better for people who plan to continue working past age 70. It can be used as a supplemental way to save once the maximum annual pretax 401(k) contribution has been made to a plan with a company match.

IMPORTANT NOTE: The maximum annual contribution to a Roth IRA is only $6,000 in 2020 (same as 2019) unless you are age 50 or over, in which case it is $7,000. The current maximum annual contribution to a 401(k) plan for non-highly compensated employees set by the IRS is considerably higher.

 A 401(k) contribution that will be matched by your employer is quite difficult to beat by a Roth IRA. However, a Roth IRA contribution is almost always better than an unmatched after-tax 401(k) contribution. Both contributions are nondeductible, but tax-free, penalty-free distributions may be made from a Roth IRA if the IRA is held for at least five years, and if the distribution is made after you reach age 59½; because of death or disability; or for first-time homebuyers, subject to a $10,000 lifetime limit.

If the 401(k) contribution is unmatched but pre-tax, then the answer depends on how your tax rate is expected to fluctuate upon retirement. If your tax rate will increase in retirement, the Roth IRA is usually more favorable. If your tax rate will decrease in retirement, the 401(k) may be more beneficial.

Also consider the investment choices made available by the employer in a 401(k) plan and the ability to take a loan against your account balance. In a Roth IRA you can invest in a wider range of assets, but loans are not permitted.