The Difference Between Roth IRA and Roth 401(k)

With similar names and functions, it is easy to confuse a Roth IRA and a Roth 401(k), but there are some important differences.

What is the same?

Tax Treatment

  • Both investment vehicles allow you to contribute after tax money and withdraw the original investment and returns tax free after the age of 59½, if you have had the account open for at least 5 years.

What are the differences?

Eligibility

  • Roth 401(k) is an employer sponsored retirement plan. If your employer offers a Roth option and you are eligible to participate in the plan, you can contribute. There is no income limit on your ability to contribute to the Roth source.
  • Roth IRAs do have income limits. See irs.gov for the current annual income limits based on your modified adjusted gross income.

Contributions

  • Roth 401(k) contributions are deducted from your payroll and deposited directly into your employer sponsored retirement account.
  • Roth IRA contributions must be made by the individual. You have to open up an account and either write a check or setup automatic contributions from your bank account.

Contribution Limits

  • Roth 401(k) contributions are based on annual 401(k) contribution limits. For 2019, you may defer earned compensation to a maximum of $19,000. An additional $6,000 may be deferred as a catch-up contribution for individuals age 50 and over. It is important to note this limit is a combined limit of all Traditional and Roth contributions to your 401(k).
  • Roth IRA contributions are much lower – limited to $6,000 for 2019, $7,000 if you are over the age of 50.

Contributing to one does not affect your ability to contribute to the other. Therefore, if you are eligible for both, you could contribute up to $25,000 into Roth accounts for 2019, $32,000 if you are over the age of 50.

Investment Options

  • In a Roth 401(k) you are limited to the investment options available to you through the employer sponsored retirement plan.
  • In a Roth IRA, you typically have unlimited fund options for investing your account.

Withdrawal Options

  • Roth 401(k) accounts are more restrictive when it comes to accessing your money. As a current employee of the 401(k) sponsor, you may or may not have the option to take a loan or hardship distribution depending on the plan provisions.  Distributions are generally allowed at any time by former employees.  However, if you are under the age of 59½, any of the options may have consequences such as a 10% tax penalty on allocated earnings for early withdrawal.  If you are over the age of 59½, most plans allow you to take distributions even if an active employee at that company.
  • Roth IRAs have fewer laws related to withdrawals. If you have had the account open for at least 5 years, you can take your money out at any time, but there could be penalties if you withdraw before the age of 59½. Roth IRA distributions are contributions first, so you can always take out the amount you invested without a tax penalty, which is not an option with 401(k) plans.

Required Minimum Distribution (RMD)

  • Roth 401(k) money is subject to the age 70½ RMD rules and calculations. If trying to avoid RMDs, you may be able to rollover money into a Roth IRA.
  • Roth IRA money is not subject to the age 70½ RMD calculations.

This article was authored by Virginia Debbink, Retirement Plan Account Manager with M3 Financial.

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Investment advisory services offered through M3 Financial, a registered investment advisor and separate entity from M3 Insurance.

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