Roth 401(k) vs. Roth IRA: What’s the Difference?
The Roth 401(k) and the Roth IRA—both have that word Roth, and both have similar tax benefits. But which one should you contribute to? This article covers the differences to help you decide the answer to the question “Should I fund a Roth IRA or Roth 401(k)?”
How Are the Roth IRA and Roth 401(k) Alike?
Whether you own the IRA or 401(k) plan, each gets the name Roth from the senator, William Roth, who sponsored the legislation establishing Roth IRAs. And with both Roth IRAs and Roth 401(k)s, you make contributions on an after-tax basis. That means you don’t reduce your taxable income in the year you make the contributions, but you do receive some significant tax advantages:
Your contributions grow tax-free.
Your qualifying distributions are also tax-free.
Tax-free distributions can help provide income flexibility in retirement. And if you agree with analysts who believe our tax rates will increase, knowing that you have tax-free income buckets in retirement can give you some peace of mind.
How Are Roth 401(k)s and Roth IRAs Different?
These two retirement accounts differ in significant ways, including:
How they’re offered: Your employer may provide access to a Roth 401(k) as part of your 401(k) plan. You open a Roth IRA on your own through a broker, custodian, or mutual fund.
Contribution limits: You can contribute more to an employer-sponsored plan than an IRA. For 2021, you can save $19,500 toward a 401(k)/Roth 401(k) versus $6,000 toward a traditional IRA/Roth IRA.
Catch-up contributions: Once you reach age 50, you can contribute an additional amount to your retirement accounts: $6,500 in 2021 for a 401(k)/Roth 401(k) versus $1,000 for a traditional/Roth IRA.
Employer matching contributions: Your employer’s contributions to your 401(k) plan can help super-charge your retirement savings. Unfortunately, with a traditional or Roth IRA, you won’t enjoy that benefit. [Note that your employer’s contributions will be added to your regular 401(k), not your Roth 401(k).]
Income limitations: You don’t face income limitations with Roth 401(k)s. However, your ability to contribute to a Roth IRA is phased out as your income climbs. It’s entirely eliminated once your modified adjusted growth income (MAGI) reaches $140,000 (individuals) or $208,000 (married filing jointly).
Investment options: Your options with a Roth 401(k) are limited to those offered by your plan’s administrator, and you are subject to the 401(k) plan’s fees. Your options with a Roth IRA are much broader, and you can shop around for an IRA with low account expenses.
Required minimum distributions: When you reach age 72, you need to begin taking RMDs from your Roth 401(k). (You can avoid this if you are still working for the company sponsoring your plan and you aren’t a 5%-or-more owner of the company.) You aren’t required to take any distributions from a Roth IRA, offering an opportunity for further investment growth.
Which Account Is Best for You?
The answer to this question depends on your financial situation and goals. If you are a high-income earner, you may find a Roth 401(k) more beneficial since you don’t face the income limitations of a Roth IRA. You can also receive employer matching contributions, which is essentially free money for your retirement.
A Roth IRA, on the other hand, has more investment options and no RMDs (which will extend to your spouse if they inherit your Roth IRA).
Our fiduciary wealth management firm in Roseville and Folsom, CA, works with couples and individuals to select retirement accounts in light of their financial and tax situation. Consider talking with a fiduciary financial planner so that you know how a Roth IRA, Roth 401(k), or both fit into your financial plan.
Schedule a complimentary, 15-minute call with a fee-only, fiduciary financial advisor today to discuss your personal situation.
This material was prepared by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax or legal advice.
Parkshore Wealth Management is a family-owned, independent, fee-only Registered Investment Advisor serving the greater Sacramento area with an office in Roseville, CA. We partner with financially responsible individuals and families who are eager to take positive steps that will allow them to use their money to build the life they desire. The firm is led by Harold Anderson, CFP®, and Daniel Andersen, CFP®, both members of NAPFA, the country's leading professional association of fee-only financial advisors.