Roth 401(k)s and IRAs are alternatives to traditional 401(k)s and IRAs, which provide a tax deduction on contributions instead of allowing tax-free withdrawals. Roth 401(k)s and Roth IRAs both let you contribute money after you’ve paid taxes on it, so you can later withdraw the money, plus any earnings, tax free in retirement.
What’s the Difference Between a Roth 401(k) and a Roth IRA?
Both Roth IRAs and Roth 401(k) plans allow for after-tax contributions, but the retirement offerings have some big differences. The most significant differences between a Roth 401(k) and a Roth IRA are the eligibility requirements to open one. There are also income restrictions on who can contribute to retirement accounts. Roth 401(k)s don’t limit contributions based on your income. You can contribute as much as you like from the income you earn from that employer, up to the maximum contribution. But you must stay below certain income limits to contribute to a Roth 401(k). Single filers must have a modified adjusted gross income (MAGI) of $144,000 or less in 2022. Married filers must have a MAGI of $214,000 or less. These limits increase in 2023 because they’re indexed to keep pace with inflation. Married filers can qualify in 2023 with MAGIs of $228,000. The limit is $153,000 for single filers.
Contributions
Another major difference between Roth 401(k)s and Roth IRAs is the amount that you can contribute each year. Traditional and Roth 401(k)s have much more generous contribution limits, letting you set aside more than three times as much for retirement. You can contribute up to $20,500 to a 401(k) in 2022, compared to just $6,000 to an IRA. The $20,500 threshold is a combined limit for Roth and pre-tax contributions. You can contribute an additional $6,500 to your 401(k) or an additional $1,000 to your IRA if you’re 50 years old or older. These limits increase to $22,500 and $6,500 respectively in 2023, with catch-up contributions at age 50 or older set at $7,500 and $1,000 respectively. Contributions to 401(k)s are made through payroll deductions, so you can’t contribute more to the account than what you make from the employer that’s offering the account. IRA contributions are similarly capped by your earned income if you make less than the typical annual limit.
Required Distributions
Some retirement accounts force you to start withdrawing money when you reach a certain age. You must begin taking required minimum distributions (RMDs) from a Roth 401(k) by age 72 unless you’re still employed, or you own at least 5% of the business that’s offering the 401(k). Roth IRAs have no required minimum distributions as long as the account’s owner is alive.
Investment Options
Your employer typically partners with a brokerage firm and offers a selection of investments that employees can choose from and place in their Roth 401(k) plans. This might include a list of stocks, bonds, and mutual funds. Some employers will give employees more flexibility, but many are stuck with just a small selection of funds. You have the flexibility to choose your broker and your own investments with a Roth IRA, as long as they’re not prohibited to be held in a Roth account. Investing in collectibles via an IRA is generally not allowed, or it may result in additional taxes.
Which Is Right for Me?
You can open both a 401(k) and an IRA. Common advice is to first contribute enough to your 401(k) to max out your employer’s match if you have both plans. After that, you can contribute to your IRA where you have more flexibility to choose what you want to invest in. Then you can then return to contributing to your 401(k) if you max out your IRA and want to keep saving. Of course, you should take full advantage of the type of plan you have access to if you’re only eligible for one of the two accounts due to income limits or not working for an employer that offers a 401(k),
Other Information
The odds are good that if your employer or brokerage offers a Roth 401(k) or IRA option, it also offers traditional retirement accounts. Unlike Roth accounts, these traditional options let you deduct money from your income when you contribute and pay taxes on the withdrawals. This is the opposite of Roth accounts, which are tax free at withdrawal, but you must pay tax on the money you contribute in the year you do so.
The Bottom Line
Roth 401(k)s and IRAs are similar, allowing you to save money for retirement while receiving some tax benefits. But Roth 401(k)s have much higher contribution limits at the cost of only being available through employers. It’s well worth doing if you have the option to use an IRA or 401(k) to save for retirement. The tax incentives can potentially help you save more.
