Sean Casterline

Roth IRA vs. Roth 401(k)

 Sean Donovan Casterline

Sean Donovan Casterline

Which Retirement Account Is Right for You?

Planning for retirement doesn’t have to be confusing or stressful. Based on your unique financial profile, you can create a retirement plan that meets your long-term goals. Roth accounts are central to this process, with these after-tax accounts providing unique benefits to people of all ages. When researching Roth accounts, it’s important to distinguish between Roth 401(k) plans and Roth IRAs. There are advantages and disadvantages associated with both account types, and key differences regarding contributions, distributions, and income, among other factors.

Let’s take a closer look at Roth accounts so you can decide which account is right for you and your family.

What is a Roth IRA?

Roth IRAs are similar to traditional IRAs (individual retirement accounts), both of which allow qualified withdrawals on a tax-free basis when certain conditions are met. Unlike traditional IRAs, however, Roth IRAs are funded with after-tax funds. A Roth IRA is a special individual retirement account where contributions are not tax-deductible but withdrawals are tax-free. These accounts were established by the Taxpayer Relief Act of 1997, and they remain popular across the United States. If you have a 401(k) with a previous employer, it can be rolled over into a Roth IRA.

What is a Roth 401(k)?

Roth 401(k)s combine elements of traditional 401(k)s with elements of Roth IRAs to give employees extra options when planning for retirement. As a hybrid solution, these retirement accounts offer the best of both worlds to people with a particular financial profile. Like traditional 401(k)s, contributions are made from your paycheck and possibly matched by your employer. Like Roth IRAs, taxes are paid before funds reach your account and withdrawals are tax-free. These accounts were created by the Economic Growth and Tax Relief Reconciliation Act of 2001.

Key differences between Roth accounts

Roth IRAs and Roth 401(k)s both have unique features, which makes them attractive to different people at different stages of retirement planning. From contributions to distributions and income limits, let’s take a look at the key differences:

Contribution limits

Based on IRS figures, Roth 401(k)s have a much higher contribution limit than Roth IRAs, at $20,500 with a ceiling of $27,000 per year compared to $6,000 with a ceiling of $7,000 per year in 2022. This deductible amount changes periodically, and the ceiling limit only applies to people aged 50 years or over.

Minimum distribution

Roth IRAs benefit from a lack of required distributions, both while the account holder is living and after they have passed. A Roth IRA can exist forever, with the person who inherits the IRA not required to take distributions or pay taxes after the death of the initial account holder. However, anyone other than the spouse is required to make a minimum withdrawal each year.

Income limits

There are income limits for Roth IRA contributions, and no income limits for Roth 401(k)s. Based on IRS figures for 2022, individual taxpayers who make $144,000 or more are not eligible for Roth IRA contributions, nor are married couples filing jointly who make $214,000 or more. Single taxpayers can only contribute the maximum amount to a Roth IRA if their income is less than $129,000, or $204,000 for married couples.

Investment options

Roth IRAs provide investors with much greater control over their accounts compared to Roth 401(k)s. Roth IRA investors can choose between individual stocks, bonds, and funds, while 401(k) plans are limited to whatever is available from the employer. Along with freedom of choice, Roth IRAs allow you to shop around based on transaction costs and admin expenses.

Withdrawal flexibility

Roth IRAs are much better when it comes to withdrawals, with account holders able to withdraw all of their contributions without penalties or taxes. This flexibility does not exist for IRA earnings, however, which come with a 10% penalty for pre-retirement account holders under 59 1/2 years of age. There are exceptions, however, with penalties eliminated for first home buyer and childbirth costs.

Deciding between a Roth IRA and Roth 401(k) account can be challenging. The right option for you depends on your current age and lifestyle, along with your financial plans and long-term goals. In most cases, high earners should consider a Roth 401(k) due to the lack of contribution limits and income caps. On the other side of the coin, people who value flexible distributions and withdrawals may prefer a Roth IRA.

If you’re looking for capital management professionals to help you make the right decision, please contact our team today.