Comparing a Roth IRA and Roth 401(k)

January 15, 2021

Comparing a Roth IRA and Roth 401(k)

There can be confusion when it comes to the Roth name before retirement planning vehicles. This is an attempt to explain the difference between two very common retirement plans with Roth options – the Roth IRA and the Roth 401(k).

Let’s start with the “Roth” part. Named after the senator that first introduced the legislation, having Roth in front of IRA or 401(k) means that contributions into the plan are made with after-tax dollars (money that’s already be subject to income taxation).

When the account owner reaches a specific age (typically age 59.5) any distributions, including earnings (growth) are tax free.

Roth IRAs allow annual contributions based on earned income (W2 or self-employed income) up to $6,000 or $7,000 annually (if over age 50). Roth IRAs also allow access to your contributions at any time without penalty, and do not have required minimum distributions at age 72.

Finally, you can have a Roth IRA regardless of having a Roth 401(k). You must have earned income and your adjusted gross income (AGI) must be below certain limits.

Roth 401(k)s are like Roth IRAs in that they allow annual contributions based on earned income (W2 or self-employed income). However, annual maximum contributions are higher at $19,500 or $26,000 (if over age 50). Roth 401(k)s have required minimum distributions at age 72.

Roth 401(k)s do not have income limitations, meaning high income earners still have a chance to save a Roth account.

A potential limitation of a Roth 401(k) is that it’s an employer sponsored plan. Unless your employer offers a Roth 401(k) option (or you’re self-employed) you cannot contribute to one.

Contributions are also made via payroll deductions only. You cannot write a check or deposit cash directly from your bank account like you can to a Roth IRA.

Given the choice, save as much as you can to a Roth IRA and or Roth 401(k). It means tax free wealth in retirement and the majority of your distributions (the longer you’re invested) will be earnings (growth) free from taxation.

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