A Quarter of Americans Think They’ll Get No Social Security Checks. Are They Right?

Millions of Americans have no confidence in Social Security. In fact, according to a recent nationwide study, 25% of all adults think they won’t get a dime of their earned retirement benefits. This includes 47% of millennials, 33% of Gen Xers, and 12% of Baby Boomers.

The big question is, Is this a valid concern?

a person sitting at a table: Couple reviewing financial documents with calculator.

Are Americans right to be worried about the future of Social Security?

There is some basis for concern about Social Security‘s financial stability.

Each year the program’s trustees release a report about its finances. And the most recent one suggested its trust fund would run dry in 2035. This report was pre-COVID, and there’s plenty of evidence to suggest the pandemic accelerated this timeline and the trust fund could run out of money sooner.

However, while the trust fund is in trouble, that doesn’t mean Americans won’t get any of their Social Security benefits. In fact, because of the way the program is structured, it’s virtually impossible for retirees to end up with no benefits.

Gallery: 14 Key Differences Between a 401(k) and a Roth IRA (The Motley Fool)

Investors should know the rules of each

Both a 401(k) and a Roth IRA are accounts that can be used to save for retirement. But they work differently in terms of tax breaks, how you invest in them, and when and how you can withdraw your funds.

If you’re making a decision about how to invest for your later years, make sure you understand these 14 key differences between a 401(k) and a Roth IRA so you can put your money in the best type of account for your needs.

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1. Eligibility to open an account

A 401(k) is generally offered to workers by an employer. That means if your company doesn’t offer a 401(k), you likely are not going to be able to contribute to this type of retirement savings plan.

A Roth IRA, on the other hand, can be opened by just about anyone. Regardless of whether your employer offers you a retirement savings account or not, you can make the decision to open your own Roth IRA to save for your future.

2. Income limits for contributing

No matter how much money you earn, you are allowed to contribute to a 401(k) account. That’s definitely not the case for a Roth.

There are strict income limits to be eligible to make contributions to a Roth IRA. If you exceed them, you can’t just open this type of account and put money into it.

You can potentially take advantage of an option called a “backdoor IRA,” which involves contributing to a traditional IRA and then doing a Roth conversion. However, this can be a lot more complicated.

3. Contribution limits

There are annual limits on how much you can contribute to both a 401(k) and a Roth IRA. However, the contribution limits for a 401(k) are much higher.

In 2021, for example, you can contribute $19,500 to a 401(k) and an additional $6,500 if you are over 50 and eligible for catch-up contributions. That adds up to a $26,000 total maximum contribution.

By contrast, you are allowed to contribute a total of $6,000 to Roth and traditional IRAs in 2021 (that’s an aggregate limit applicable to both account types). And the catch-up contribution amount is a total of $1,000, so the maximum Roth IRA contribution for those 50 or over would be $7,000.

4. Availability of employer match

If you have access to a workplace 401(k), you may be able to get matching funds from your employer. This means that your employer would match a part of your contributions, such as 50% of the amount you put in up to 6% of your salary.

There is no employer contribution for a Roth IRA.

Because a 401(k) provides free money but a Roth IRA doesn’t, you should always prioritize contributing enough to your 401(k) to get your full employer match. That way, you can take advantage of the free money your employer is willing to provide.

5. Choice of where to invest

Because employers open 401(k) accounts, you don’t have a choice of what bank or brokerage firm to invest your money in. You simply have to invest with the 401(k) administrator that your company has chosen.

With a Roth IRA, you can open your account with virtually any brokerage firm or financial institution that offers this type of account. This gives you a lot more flexibility in what you do with your money.

ALSO READ: Best Roth IRA Accounts for July 2021

6. Type of investment options

Most 401(k) accounts provide very limited choices when it comes to investments. You may have a dozen or so target date funds or mutual funds or exchange-traded funds (ETFs) that you can invest in — and that’s it.

But since you can open a Roth IRA anywhere, you have a much broader choice of what you invest in.

Depending on the brokerage or financial institution where you hold your Roth IRA, you may be able to invest in many different kinds of assets including stocks, bonds, mutual funds, and more.

7. Tax breaks for contributions

When you contribute to a 401(k), your contribution is made with pre-tax dollars. You get your tax savings in the year you make the contribution, and the money you invest in this account doesn’t reduce your taxable income by as much.

Roth contributions are made with after-tax money. You do not get to claim a tax break when you deposit funds. But you get your tax savings later, as a senior.

If you expect to be in a lower tax bracket later in life, then a 401(k) could be a better option. But if you think your tax rate will go up in the future, then you may prefer a Roth.

8. Methods of contributing

To contribute to a 401(k), you’ll sign up with your plan administrator at work. When you sign up to contribute, money is taken directly out of your paycheck before you receive the check from your employer.

Roth IRA contributions don’t come out of your paychecks automatically. You’ll have to move money over into your account yourself. If you want to automate the process, you’ll need to arrange this with your bank or brokerage firm.

9. Vesting of contributions

You are the only one contributing to your Roth IRA, so you don’t have to worry about vesting.

But things are a little different with a 401(k).

Money you contribute to a 401(k) is always vested immediately and yours to keep. But employer contributions may come with a vesting schedule. That means you might have to stay at your job for a certain length of time in order to be eligible to keep this money.

10. Ability to borrow against your account

In many cases, it is possible to borrow against a 401(k) and pay yourself back with interest.

While not all plans allow this, many do. And while there are risks to raiding your retirement account, a 401(k) loan can still be a good option when you need to borrow and don’t want to pay interest to a creditor or can’t qualify for a loan from a creditor.

You cannot borrow against a Roth IRA.

ALSO READ: 3 Reasons a 401(k) Loan Is Better Than an Early Withdrawal

11. Options for penalty-free withdrawals

If you take money out of your 401(k) before 59 1/2, you are generally hit with a 10% early withdrawal penalty.

This penalty also applies to a Roth IRA, but only to gains from contributions. It’s possible to make penalty-free withdrawals of money you contributed at any time, since the money that you deposited was after-tax money.

12. Amount of time your account must be open before making penalty-free withdrawals

Once you hit 59 1/2, you can generally begin making penalty-free withdrawals from your 401(k) regardless of how long you have had your account open.

With a Roth IRA, an additional rule called the five-year rule applies. If you haven’t had your account open for long enough, you could face penalties and taxes on distributions.

13. Taxation as a senior

When you take distributions from a 401(k) as a retiree, you’ll be taxed at your ordinary income tax rate.

If you take money out of a Roth, however, you will not owe taxes on the distributions at all — provided you’ve followed all the rules for your account.

The money you’ve withdrawn also won’t count toward determining whether Social Security benefits can become taxable — which can occur once your income crosses a certain threshold.

ALSO READ: 3 Ways to Avoid Taxes on Your Social Security Benefits

14. Required minimum distribution rules

401(k) plans are subject to required minimum distribution (RMD) rules. These require you to begin withdrawing money from your 401(k) after you reach age 72. The specific amount varies based on your age, life expectancy, and account balance.

Roth IRAs do not have RMD rules during the account holder’s lifetime, so the money can remain invested as long as you want.

Should you choose a 401(k) or Roth IRA?

As you can see, there are huge differences between investing in a Roth IRA versus in a 401(k). The good news is, in most cases, you don’t have to choose between them. You can invest in both so you have a mix of different retirement assets.

The best choice for you will depend on many factors including your retirement goals, income, and current and future tax brackets.

Now that you know the difference between the two account types, you can make an informed choice about how each one should factor into your retirement plans.

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16/16 SLIDES

See, Social Security is funded by payroll taxes collected from current workers. As long as these taxes keep coming in — which they will as long as people keep working — there will be money available to pay benefits to retirees.

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While lawmakers could theoretically end payroll tax collection (President Trump set this as a goal), it would be very difficult politically because it would end Social Security as we know it — which isn’t a very popular idea.

That means future retirees really don’t have to worry about not getting a dime from the program.

While Social Security benefits won’t disappear, cuts could happen

Although there’s virtually no chance of Americans getting no Social Security benefits, there’s a real risk they’ll get less than they were promised.

While payroll taxes will keep coming and provide enough to pay out some promised benefits, they can’t provide the full amount of retirement income future retirees are due. In fact, unless lawmakers make changes before the trust fund runs dry in 2035, an automatic 24% cut to benefits would have to occur when the money runs out.

Lawmakers are very unlikely to let seniors lose so much of their monthly income, so they will probably find some way to shore up the program’s finances before that happens. Unfortunately, most methods of doing that will end up with retirees getting less money.

Lawmakers could end up changing the full retirement age, which they did in 1983 when Social Security was last subject to major reforms. If FRA is pushed back, future retirees will either get hit with more early filing penalties or have to wait longer to get benefits. Both of these options would leave retirees with less total benefits.

Other changes, such as making more benefits subject to tax or changing the way cost-of-living adjustments are calculated, could also result in de facto benefit cuts.

The bottom line is, if you’re among the quarter of Americans worried that Social Security will provide you with no benefits, your concerns are unfounded. But all future retirees should be aware of the very real potential for benefit cuts and should plan to have sufficient retirement savings to support themselves — even with Social Security checks that are a bit smaller than anticipated.