Roth 401(k) vs. Roth IRA: How each of these after-tax retirement accounts can help maximize your savings

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  • The Roth 401(k) and Roth IRA are two different types of retirement vehicles that allow you to invest after-tax dollars.
  • A Roth 401(k) is offered through your employer, and a Roth IRA is set up individually.
  • A Roth 401(k) has stricter rules but higher contributions, while a Roth IRA has lower contributions and more flexibility.
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The Roth 401(k) and Roth IRA are two of the many options you can choose from in deciding how to invest. Though the names are similar, these plans differ in several important ways. Which one is the right fit for you will depend on your age, time horizon, annual income, and financial goals.

Roth 401(k) vs. Roth IRA: At a glance

The term 401(k) refers to the tax code in which these employer-sponsored plans were created. IRA stands for independent retirement arrangement. The key difference between the Roth versions of these types of accounts and their traditional counterparts is how the tax advantages work.

  • A Roth 401(k) is offered by employers. Similar to a traditional 401(k), this type of plan is provided as a benefit. Unlike a traditional 401(k), the contributions you make to a Roth 401(k) are with after-tax dollars. Qualified withdrawals are tax free.
  • A Roth IRA isn’t tied to an employer. If you meet the eligibility requirements, you can save for retirement using a Roth IRA through a brokerage like Fidelity or Vanguard and invest after-tax dollars. Qualified withdrawals are also tax free.

“‘Roth’ means that the accounts are funded with after-tax dollars,” explains Brandon R. Amaral, a certified financial planner and founder at Amaral Financial Planning. “You don’t receive a tax deduction, however any growth in the account is tax free.”

What is a Roth 401(k)?

The Roth 401(k) was established under sweeping tax-reform legislation passed in 2001. It combined elements that already existed in a traditional 401(k) with those of the Roth IRA . Employers were given the option to implement the Roth 401(k) in 2006.

Roth 401(k) accounts are only available through your employer. As part of your benefits package, your employer may match your contributions up to a certain percentage. However, it’s important to note that any Roth 401(k) contributions by your employer are made with pre-tax dollars to a traditional 401(k) account that is taxable upon withdrawal. The contributions you make are after tax, and post-retirement distributions are tax free.

On top of that, you want to be aware of vesting, which refers to ownership of the retirement account as it relates to employer contributions. Your employer may have certain time requirements for you to meet until you’re 100% vested, or in other words, entitled to all the money in the retirement account. Your own contributions are immediately 100% vested.

Roth 401(k) accounts don’t offer any tax breaks now, as you use after-tax dollars. But the benefit is that you get earnings and withdrawals tax-free later on if it’s a qualified distribution. You must be 59 ½ or older to qualify for tax-free withdrawals. If you withdraw before then, you could be hit with a 10% early withdrawal penalty and owe income tax. There may be certain situations such as death and disability where you can avoid these penalties. 

One of the benefits of a Roth 401(k) vs Roth IRA is that you can contribute more to your account. 

“With a Roth 401(k), you can contribute up to $20,500 ($27,000 if you are over 50) in 2022,” notes Amaral. “With a Roth IRA, you can contribute up to $6,000 ($7,000 if you are over 50) in 2022.” 

When you reach retirement age, you can enjoy your funds tax-free. You must take a required minimum distribution by age 72, if you haven’t already. A Roth 401(k) can be a good choice if you’re in a low tax bracket now and expect to be in a higher tax bracket come retirement.

Roth 401(k) pros and cons

What is a Roth IRA?

A Roth IRA is an account that you can use to invest for retirement on your own, without an employer. You use after-tax dollars now, so you avoid paying taxes later on when it’s time for a distribution. The big difference between a Roth IRA and a Roth 401(k) is its flexibility. 

“Roth IRAs also allow penalty-free distributions for first-time home purchases, education expenses and unreimbursed medical expenses,” Amaral says. 

Roth IRAs are good for young investors who expect to be in a higher tax bracket later on. However, there are income eligibility requirements to contribute to a Roth IRA. The amount you can contribute is much less than a Roth 401(k). The maximum is $6,000, or $7,000 if you’re 50 or older. But it may be good in exchange for the flexibility a Roth IRA comes with. 

“While you can save more for retirement in a Roth 401(k), a Roth IRA offers more flexibility for withdrawals. With a Roth IRA, you are able to withdraw your contributions after five years to avoid any taxes or penalties,” notes Amaral.

But first you need to see if you even qualify for a Roth IRA.

You can contribute up to the limit if you’re single and your modified adjusted gross income (AGI) is less than $129,000. If it’s beyond that up to $144,000, you can only contribute a reduced amount. If you’re married, you can contribute up to the limit if your modified AGI is less than $204,000. If it’s beyond that up to $214,000, you also can only contribute a reduced amount. If your income goes beyond these thresholds, you’ll no longer be eligible to contribute. 

One of the benefits a Roth IRA has over a Roth 401(k) is that there are no required distributions while the account owner is alive. So you can take money out when you want, and never be forced into it. The money can also be used for first time home-buying or health insurance premiums while unemployed, which makes it an attractive and flexible retirement savings vehicle.

Though there is more flexibility with withdrawals using a Roth IRA, if you tap the earnings on your investments before age 59 ½, that money will probably be taxed as regular income, plus a 10% penalty, with certain exceptions.

Roth IRA pros and cons

The financial takeaway

Though both Roth 401(k) and Roth IRA accounts use after-tax dollars and both are used for retirement, they vary in who they are geared toward as well as who is eligible. For example, a Roth 401(k) is only available through your employer, while a Roth IRA is only available to you if you meet certain income requirements. The amount investors can invest is also a big consideration.

“The main considerations for choosing which retirement vehicle is for them is their short-term goals, current cash flow, and time horizon to retirement,” notes Amaral. “If you are young, it may be wise to contribute to a Roth IRA and keep your assets liquid to help fund a potential home purchase or wedding. If you are in your 50s, you can save more money toward retirement to catch up in case you are behind.”