Student-Friendly Investing
Roth IRA vs. 401(k): A Lifetime Investing Guide
Clear, practical guidance for an 18-year-old starting with $80–$120 per month. See how Roth IRAs compare to 401(k)s, why starting early matters, and exactly how contributions can grow over time.
Roth IRA — Pros
- Tax-free growth and tax-free withdrawals in retirement.
- Withdraw contributions (not earnings) anytime with no penalty.
- Ideal for low tax bracket years (college/early career).
- Broad investment choice (index funds, ETFs, etc.).
- No required minimum distributions (RMDs).
Roth IRA — Cons
- Contributions are after-tax (no upfront tax break).
- Must have earned income in the tax year you contribute.
- Annual contribution limit: $7,000 (2025) or up to earned income.
- Early withdrawal of earnings may incur taxes/penalties.
401(k) / 403(b) — Quick Facts
- Pre-tax contributions reduce taxable income now.
- Potential employer match = free money.
- Withdrawals are taxed as income in retirement.
- Limited to plan’s investment menu; early withdrawals penalized.
Bottom line for a student: Start a Roth IRA first (if there’s earned income). If a job offers a 401(k) match, contribute enough to get the match, then keep funding the Roth IRA. This creates powerful tax diversification over time.
Why the Roth IRA Is Especially Powerful Early in Life
1) Low Tax Bracket Advantage
Paying taxes now (when rates are low) beats paying later on a larger balance. Roth locks in today’s low rate, and future withdrawals are tax-free.
2) Tax‑Free Growth
All dividends and gains compound tax‑free. At 59½+ (and 5+ years after opening), withdrawals are completely tax‑free.
3) Flexibility & Control
Choose broad, low‑fee index funds. Contributions can be withdrawn anytime without tax/penalty, offering an emergency backstop.
4) No RMDs
Unlike traditional accounts, a Roth IRA doesn’t force withdrawals — letting money grow as long as you like.
Earned Income & Contribution Rules (for Students)
- What counts as earned income? W‑2 wages (part‑time/summer jobs), 1099 freelance income, tips/commissions reported to the IRS.
- What doesn’t? Scholarships for tuition, investment income, gifts/allowance.
- Annual test, not monthly: You don’t have to be working when you contribute — you just need earned income for that tax year. Contributions are allowed until the tax filing deadline (typically mid‑April of the following year).
- Limit: You can contribute up to your earned income amount or the annual cap ($7,000 in 2025), whichever is less.
- Parents can fund it: Money can come from anyone, as long as the student has enough earned income to cover the contribution.
- If income is $0 for the year: Pause contributions; the account stays open and invested.
Example: Earns $3,000 from January–July. Can contribute up to $3,000 to a Roth IRA anytime before the next year’s tax deadline — even if not working the rest of the year.
How a Roth IRA Fits with a 401(k) Over a Lifetime
| Life Stage |
Main Focus |
Why |
| College / Early 20s |
Roth IRA |
Low taxes now; maximize tax‑free compounding. |
| Mid‑20s to 30s |
401(k) up to match + Roth IRA |
Free employer money + tax diversification. |
| 30s–50s |
Increase both as income allows |
Accelerate compounding and flexibility. |
| 50s+ |
Maintain both; catch‑up contributions |
Boost savings before retirement; preserve options. |
Quick Comparison: Roth IRA vs 401(k)
| Feature |
Roth IRA |
401(k) |
| Tax Treatment |
After‑tax → Tax‑free later |
Pre‑tax → Taxed later |
| Withdrawal Taxes |
None (59½+ & 5‑year rule) |
Fully taxable as ordinary income |
| Employer Match |
No |
Yes (if offered) |
| Investment Choice |
Broad (index funds/ETFs) |
Plan menu, may be limited |
| Access Before 59½ |
Contributions anytime |
Generally penalized |
| RMDs |
No |
Yes (typically beginning at 73) |
Growth Overview (Age 18 → 65)
Assumes monthly contributions and average annual returns of 6%, 8%, and 10%. These are long‑term averages — year‑to‑year results vary.
| Monthly Contribution |
6% Return |
8% Return |
10% Return |
| $80 |
$202,640 |
$299,247 |
$448,578 |
| $100 |
$253,300 |
$374,058 |
$560,722 |
| $120 |
$303,960 |
$448,870 |
$672,866 |
Reminder: If there’s an employer match available in a 401(k), contribute enough to capture the full match before adding extra to non‑matched accounts. Then continue prioritizing Roth IRA for tax‑free growth.