Roth IRA vs. Money Market Account: What’s the Difference?
When you’re looking for a place to store your money, you have plenty of options to choose from. The best account for you usually depends on your financial goal, when you expect to need the money, and your overall financial situation. For example, you’d use a very different type of account to save for retirement than you would for a vacation you’re taking later this year.
Two of the most popular financial accounts are the Roth IRA and the money market account. The two have very different features, purposes, and tax consequences. We’ll explain how each account works in this article, as well as their differences and how to decide between the two.
What’s a Roth IRA?
A Roth IRA is a type of individual retirement account that allows workers to invest for retirement while reducing their tax burden in the future.
When you contribute to a Roth IRA, you do so with after-tax money but then never have to pay taxes on those funds again. Your investments grow tax-free in the account, and you can take tax-free distributions during retirement.
In 2022, the IRS allows you to contribute up to $6,000 per year to a Roth IRA, with an additional catch-up contribution of $1,000 for workers 50 and older. However, you must have earned income to contribute to a Roth IRA and can only contribute up to 100% of your income. So if you earned less than $6,000 in a year, you can’t contribute the full contribution limit.
The IRS also places income limits on who can contribute to a Roth IRA. In 2022, you can only contribute the full amount if you earn less than $129,000 as a single filer or $204,000 as a married filer. Once you earn $144,000 as a single filer or $214,000 for a married filer, you won’t be able to contribute at all.
Once you’ve contributed money to your Roth IRA, you can invest it in nearly anything. Most brokerage firms offer a wide variety of investment choices, including individual stocks and bonds, mutual funds, exchange-traded funds (ETFs), and more.
Like other retirement accounts, you generally can’t withdraw money from your Roth IRA before age 59½ without facing penalties. However, because you’ve already paid taxes on your contributions, you can withdraw those contributions — but not your earnings — before the withdrawal age without being stuck with a penalty.
What’s a Money Market Account?
A money market account is a type of deposit account offered by banks and credit unions. A money market account combines features of both checking and savings accounts.
Like a checking account, a money market account makes it easy to access your money. You’ll usually have check-writing privileges, as well as a debit card you can use for ATM withdrawals. But like a savings account, a money market account offers a small return on your savings. Also like a savings account, you’re limited to six withdrawals per month.
Like other deposit accounts, the money in your money market account is FDIC-insured up to $250,000 per depositor per account ownership category at each financial institution. If your money market account is at a credit union, it’s insured by the NCUA.
Roth IRA vs. Money Market Account: Similarities and Differences
Roth IRAs and money market accounts have few things in common other than being a place to store your money. The two are very different when it comes to their purpose, eligibility, tax consequences, potential return, and accessibility.
One of the most important differences between a Roth IRA and a money market account is their purpose. A Roth IRA is designed to help you save for retirement. A money market account, on the other hand, can be used for any purpose. Because of the low return, money market accounts are best for short-term financial goals for which riskier investments wouldn’t be appropriate.
As we’ve mentioned, not just anyone can contribute to a Roth IRA. You must have earned income, but it must be under the IRS limits of $144,000 and $214,000. There are no eligibility requirements for a money market account, meaning anyone can open and contribute to one.
We’ve already talked about the tax consequences of a Roth IRA, where you contribute with after-tax money and then never pay taxes on those funds again. Unfortunately, there are no tax advantages for a money market account. You contribute with after-tax money and must pay taxes on the interest you earn in your account.
Another important difference between a Roth IRA and a money market account is your potential return. A Roth IRA can be invested in nearly anything, including stocks and stock funds. To give you an idea of your potential returns, according to the Securities and Exchange Commission, the stock market has an average annual return of about 10% per year before you account for inflation and taxes.
The potential returns on a money market account are considerably lower. Interest rates available on money market accounts are correlated to the current market interest rates. As of July 2022, there are few money market accounts offering rates of 1.50% or higher.
The final key difference between a Roth IRA and a money market account is how accessible your money is. In a money market account, there are some limitations. You’ll generally have check-writing privileges and an ATM card but are also limited to six withdrawals per month. Other than that, there are no limits on when you can withdraw your money.
With a Roth IRA, you’re more limited on when you can take out your money. First, you can’t withdraw your investment earnings before 59½ without paying an early withdrawal penalty. You can withdraw your contributions early, but not until you’ve had your account open for at least five years.
What is a Retirement Money Market Account?
Up until this point, we’ve been talking about regular money market accounts. But there’s also a type of account called a retirement money market account, which exists within another type of retirement account.
When you contribute money to your retirement account, you can invest it in whatever you want. But until you’ve directed where that money should go, it goes into a retirement money market account by default. The account has all of the same characteristics as your retirement account, including contribution and withdrawal rules.
But a retirement money market account also has features of a normal money market account like you’d find at your bank, including the way the money is invested and your potential returns.
A retirement money market account isn’t intended to be a long-term solution for your money. Instead, it’s generally designed to be a temporary place to store the money in your retirement account before you decide how to invest it.
Which Should You Choose?
The biggest question to ask yourself when choosing between a Roth IRA or a money market account depends on what you plan to use the money for. If you’re saving for retirement, a Roth IRA is your best bet. But for savings goals other than retirement, a money market account is a better option.
It’s also worth noting that a Roth IRA and money market account aren’t your only options. When saving for retirement, your other options include a 401(k) plan and a traditional IRA. You might consider these alternatives based on your income level, tax bracket, and employer benefits.
For saving for goals other than retirement, you’ll also have other options. For a short-term goal — meaning one in just a few years — a money market account or savings account is probably the best option. But when saving for longer-term goals that are more than five years away, you can invest in a taxable brokerage account, which can provide a similar return to a Roth IRA.
No matter what financial goal you’re saving for, it’s important to find the right account to help you reach it. But choosing the right savings or investment account isn’t the only step. You can also use Personal Capital’s financial dashboard to reach your goals. This dashboard includes financial tools such as the savings planner, retirement planner, and budgeting tool to help you manage your money and reach your financial goals. Sign up for free today.
Author is not a client of Personal Capital Advisors Corporation and is compensated as a freelance writer.
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