Because of the Roth IRA's potential for generating tax-free earnings, many employees are choosing Roth IRAs over the 401(k) plans their companies offer. However, significant differences between a 401(k) plan and a Roth IRA make it imperative for employees to be well-informed about the unique features of each plan.

Employees can make pre-tax contributions to a tax-deferred 401(k) plan. However, taxes will be due upon withdrawal. All Roth IRA contributions are after-tax, with no up-front deductions available under any circumstances.

Current tax law allows a participant in a 401(k) plan to contribute up to a maximum of $12,000 of pay on a pre-tax basis.

Roth IRA contributions are limited to the lesser of $3,000 ($3500 for those over age 50.) or the individual's compensation. This limit is further reduced by any contributions made to non-Roth IRAs that the individual maintains for his or her own benefit.

The 401(k) plan permits plan earnings to compound on a tax-deferred basis until they are withdrawn or distributed. At that time, the participant is often retired and in a lower tax bracket. On the other hand, a Roth IRA can provide tax-free earnings. Under certain conditions, Roth IRA owners can withdraw the earnings on their Roth contributions (including interest, dividends, and capital gains) without paying income taxes.

Once eligible for plan participation, an employee can contribute to his or her 401(k) account irrespective of his or her annual income. Roth IRA contributions are limited (or not allowed) at higher income levels. Roth IRA contributions are subject to phase-out based on income, (check with a tax specialist for phase-out amounts).

An employer match of 20%, 50%, or, in some cases, 100% can really help an employee's 401(k) plan account grow over the long term.

Matching contributions are not available with a Roth IRA.

Many 401(k) plans have liberal loan provisions, allowing employees to borrow up to the lesser of $50,000 or 50% of the total value of their plan account. (Not all employers choose to make this option available to their plan participants.)

Roth IRAs do not offer a loan provision. However, a Roth IRA allows the account owner to withdraw contributions at any time without tax. (Special rules apply for amounts converted to a Roth IRA from a regular IRA.) After an individual has had a Roth account for five tax years, earnings can also be withdrawn without tax if the account owner is at least age 59 1/2 and/or meets one of the other qualifying conditions.

Whether you decide to contribute to a tax-deferred 401(k) plan or a Roth IRA depends on your own financial situation. While both plans offer the opportunity for abundant savings, their differences should be considered carefully before you invest. Always seek the advice of a tax specialist before beginning an IRA.

Emily S Hazlett is Vice-President:Investments at ENB Insurance Agency, Inc. a wholly owned subsidiary of Evans National Bank.