How a Roth 401(k) is Different than a Roth IRA - Ed Slott and Company, LLC (2024)

FAQs

How a Roth 401(k) is Different than a Roth IRA - Ed Slott and Company, LLC? ›

Roth 401(k)s do not have any income limits on contributions. If you are a high earner, you will still be able to make deferrals. That is not the case for Roth IRAs. In 2023, your ability to contribute to a Roth IRA will begin to phase out when your income exceeds $138,000 ($218,000 if you are married, filing jointly).

The biggest differences between a Roth 401(k) and a Roth IRA are their different annual contribution limits, eligibility criteria, and whether you will need to take required minimum distributions (RMDs). Let's start with the annual contribution limits.

Since an IRA is an individual account, employers do not make matching contributions to their employees' plans. Therefore, there are no matching contributions to a Roth IRA plan.

Roth 401(k)s are funded with after-tax money that you can withdraw tax-free once you reach retirement age. A traditional 401(k) allows you to make contributions before taxes, but you'll pay income tax on the distributions in retirement.

The contribution limits are the same for Roth and traditional versions of 401(k)s and IRAs. One financial strategy, for those who want to maximize their tax-advantaged savings: Open both types of Roth accounts. You can invest up to the combined allowable limits in a Roth 401(k) and a Roth IRA.

However, the Roth 401(k) earnings aren't taxable if you keep them in the account until you're 59 1/2 and you've had the account for five years. Unlike a tax-deferred 401(k), contributions to a Roth 401(k) do not reduce your taxable income now when they are subtracted from your paycheck.

Unlike a traditional Roth IRA, there are no income limits for a Roth 401(k), so these accounts are available to everyone (depending on if your employer offers one), regardless of how much money someone earns.

If an employer matches a traditional 401(k) plan contribution, it's standard for it to also offer a Roth 401(k) match, but only if the company offers a Roth 401(k) in the first place.

One of the biggest perks of a 401(k) plan is that employers have the option to match your contributions to your account up to a certain point. While the IRS places annual contribution limits on 401(k) contributions, employer matches do not count toward that limit.

It is possible to have both a Roth IRA and a Roth 401(k) at the same time. However, keep in mind that a Roth 401(k) must be offered by your employer in order to participate. Meanwhile, anyone with earned income (or any spouse whose partner has earned income) can open an IRA, given the stated income limits.

Can you withdraw Roth 401 K contributions at any time? ›

Contributions and earnings in a Roth 401(k) can be withdrawn without paying taxes and penalties if you are at least 59½ and had your account for at least five years. Withdrawals can be made without penalty if you become disabled or by a beneficiary after your death.

The maximum amount you can contribute to a Roth 401(k) for 2024 is $23,000 if you're younger than age 50. This is an extra $500 over 2023. If you're age 50 and older, you can add an extra $7,500 per year in "catch-up" contributions, bringing the total amount to $30,500.

Tax diversification: High-income earners often find themselves in higher tax brackets. A Roth 401(k) account gives you more flexibility in managing your tax liability during retirement. Having a Roth account also allows you to be strategic about the tax treatment of your investment choices.

“If you open a Roth IRA for the first time in order to receive Roth 401(k) rollover funds, then you must wait five years to take a distribution penalty-free.” This rule wouldn't prevent you from withdrawing your original contributions after the rollover is complete.

A work 401(k) is a nice perk to help you increase your retirement savings. If you're also trying to save outside of your employer-sponsored retirement plan, however, you might run into some problems. The good news is that you can contribute to an IRA even if you also contribute to a 401(k) at work.

“If you open a Roth IRA for the first time in order to receive Roth 401(k) rollover funds, then you must wait five years to take a distribution penalty-free.” This rule wouldn't prevent you from withdrawing your original contributions after the rollover is complete.

If you can afford to fund two retirement accounts simultaneously, having both a 401(k) and a Roth IRA helps you maximize your retirement-saving options since they offer opposite tax benefits. You get an immediate tax break with a 401(k) and with a Roth IRA you're essentially guaranteed a tax break in the future.

“Future tax rates are heading higher, possibly much higher, so maxing out both a Roth IRA and a 401(k) will give you more net after-tax dollars in retirement.” If your employer offers a 401(k) plan, you can choose to contribute to either a traditional 401(k) account or a Roth 401(k) account (or both).

By converting to a Roth IRA, you'll have assets that won't be taxed when withdrawn, potentially allowing you to better manage your tax brackets and enable more personalized tax planning during retirement.

Should I Convert my 401(k) to a Roth IRA? Converting a 401(k) to a Roth IRA may make sense if you believe that you'll be in a higher tax bracket in the future, as withdrawals are tax free. But you'll owe taxes in the year when the conversion takes place. You'll need to crunch the numbers to make a prudent decision.