Roth 401(k) vs. Roth IRA
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Published 1:06 p.m. UTC Nov. 14, 2023
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Key points
- Both Roth 401(k)s and Roth IRAs provide tax-free withdrawals in retirement.
- Employers may match contributions to Roth 401(k)s, while Roth IRAs may have more investment options.
- Not everyone can contribute to a Roth 401(k) or Roth IRA.
Taxes don’t disappear when you retire. But you can limit how much you pay Uncle Sam by making smart savings decisions during your working years.
Investing in Roth accounts is perhaps the easiest way to minimize tax bills later in life, and they come in two forms: 401(k)s and IRAs. While Roth 401(k)s and IRAs have the same tax benefits, they also have important distinctions you should understand before you begin investing.
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Roth 401(k) vs. Roth IRA: An overview
Roth accounts were created by the Taxpayer Relief Act of 1997 and named for the late Sen. William Roth, who championed their cause.
Unlike traditional retirement accounts, which provide tax deductions for contributions, Roth accounts are funded with after-tax dollars. But they come with other tax benefits that some say are more valuable.
The money in a Roth account grows tax-free and can be withdrawn tax- and penalty-free if you are 59½ or older and have had your account for at least five years. “That’s a huge advantage for a Roth,” said Chris Powers, managing director of relationship development for wealth advisory firm Girard.
Both Roth 401(k)s and Roth IRAs have this tax benefit, but the details of each account type differ.
What is a Roth 401(k)?
When Roth accounts were created, they were available only as IRAs. In 2006, employers were also given the option of offering Roth 401(k)s to workers.
A 401(k) is an employer-sponsored retirement account. Only employees of companies that offer Roth plans as a benefit can open one. At first, few businesses took advantage of this option, but that is changing.
“Roth 401(k) plans have been increasingly popular,” said Roger Young, a certified financial planner and thought leadership director at T. Rowe Price.
According to Plan Sponsor Council of America data, nearly 90% of employers gave their workers access to a Roth 401(k) account in 2021.
Thanks to the SECURE 2.0 Act, beginning in 2023, employees can designate that their vested employer matching or nonelective contributions be placed in a Roth account too.
What is a Roth IRA?
The IRS refers to IRAs as individual retirement arrangements, but they are more commonly called individual retirement accounts. Regardless of which word you use, these accounts are not tied to an employer.
“Not all investors are eligible to contribute to a Roth IRA,” said Scott Heise, a wealth management advisor with financial firm TIAA.
Anyone can open a traditional IRA, but there are limits on deductible contributions if you have access to a workplace retirement account. On the other hand, Roth IRAs are available only to those who meet income requirements. One exception to those requirements is if you convert funds from a traditional IRA to a Roth IRA.
Key differences between a Roth 401(k) and Roth IRA
Eligibility requirements are just one difference between Roth 401(k)s and Roth IRAs. The retirement plans also have different contribution limits and investment options.
Roth 401(k)s vs. Roth IRAs
Understanding these differences can help you make the right choice for your retirement savings needs.
Eligibility
Depending on your circumstances, you may be eligible to open one, both or neither of these accounts.
Roth 401(k)s are available to any person employed by a company offering this workplace benefit. You enroll through your human resources department and select the Roth, rather than traditional, account option.
Only people who meet certain income requirements can contribute to a Roth IRA. Your income must fall below the following levels to contribute the full amount in 2024:
- Single, head of household, or married filing separately and you did not live with your spouse at any time during the year: $146,000.
- Married filing jointly or qualifying widow(er): $230,000.
The ability to make contributions is reduced or eliminated at incomes above these amounts.
Contribution limits
One advantage of Roth 401(k)s over Roth IRAs is that you can contribute significantly more to your retirement fund each year.
Employees can contribute up to $23,000 to a 401(k) account in 2024. Those 50 or older can make an additional $7,500 in catch-up contributions.
Meanwhile, IRA contributions are capped at $7,000 for savers younger than 50 and $8,000 for those 50 or older. But you’ll have to meet IRS income guidelines to be able to contribute the entire amount. There are no income restrictions on 401(k) contributions.
Investment options
If you have a Roth 401(k) account, you are limited to the investment options chosen by your employer. A Roth IRA “does offer more flexibility,” Heise said.
Instead of selecting from a narrow menu, people with an IRA can typically choose to invest their money in a combination of stocks, bonds, mutual funds and other securities.
Tax treatment
Regarding taxes, Roth 401(k)s and Roth IRAs are treated the same. Contributions are made with after-tax dollars, meaning you don’t get a tax deduction for the cash you put into the account.
But the money grows tax-free. Once you reach age 59½ and your account has been open for five years, you can make tax- and penalty-free withdrawals.
Required minimum distributions (RMDs)
The IRS generally requires you to take minimum distributions from traditional retirement accounts at age 73. If you fail to withdraw the designated amount, you could be assessed a hefty tax penalty.
Until recently, Roth 401(k) accounts were also subject to RMDs. That changed with the passage of the SECURE 2.0 Act. Starting in 2024, you will no longer be required to take minimum distributions from Roth 401(k) plans.
How to choose between a Roth 401(k) and a Roth IRA
As you contemplate contributing to a Roth 401(k) or Roth IRA, consider the following:
- Whether you have access to both accounts.
- Whether your employer matches 401(k) contributions.
“If they give you a company match, then you would want to go with a 401(k),” Powers said. “Otherwise, you’re leaving that money on the table.”
Many people prefer 401(k) plans because they can be funded with payroll deductions, offering a painless way to save for retirement. They are also popular among those who can afford to set aside a significant amount of money.
On the other hand, some people prefer IRAs because of the freedom and flexibility they offer in selecting investments. And since they aren’t employer-sponsored plans, there is no need to worry about rolling over your balance or maintaining multiple accounts if you change jobs.
Another benefit of a Roth IRA is that it may be easier to access money before you reach age 59½, according to Young. Roth IRA contributions, already taxed, can be withdrawn anytime tax- and penalty-free.
Early Roth 401(k) withdrawals are more complicated. They are prorated between nontaxable contributions and taxable earnings in the account.
Consider a Roth 401(k) if:
- Your company will match a portion of your contributions.
- You like the convenience of contributing via payroll deductions.
- You don’t expect to leave your job soon.
Consider a Roth IRA if:
- You want to choose your investments.
- You change jobs frequently.
- You don’t expect to save more than the annual contribution limit for IRAs.
Most retirement planning experts recommend that you diversify your savings. That means having a mix of tax-deferred and tax-free money available during retirement.
But some savers may benefit more from Roth accounts than traditional accounts or vice versa. For instance, a Roth account is generally best suited for an individual who expects to be in a higher tax bracket when they start taking withdrawals.
A traditional account is generally best suited for an individual who expects to be in the same or lower tax bracket when they start taking withdrawals.
Check with a tax professional to determine whether Roth accounts, traditional accounts or a combination of both would make sense for you.
Yes, you can open and fund both a Roth 401(k) and a Roth IRA. Of course, you must meet the eligibility requirements of the IRS and/or your employer.
No. While the two accounts have the same tax benefits, they should not be confused with each other.
A Roth 401(k) is available through an employer and offered as a workplace benefit. Meanwhile, anyone who meets IRS income guidelines can open a Roth IRA.
Whether a Roth 401(k) or Roth IRA is better depends on your preferences and priorities.
If you want to save a lot of money while taking advantage of convenient payroll deductions, a Roth 401(k) may be right for you. It can also be a logical choice for anyone whose employer matches contributions.
On the other hand, if you save a more modest amount and want full control of your account, a Roth IRA may be best.
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