Retirement Savings: Roth IRA vs. Roth 401(k)

Oct 20, 2021 10:16:14 AM

If you’re not taking advantage of Roth options for retirement savings accounts, you could be missing out on the distinctive tax benefits these savings accounts offer. Curious to learn more about Roth retirement accounts and how the Roth IRA differs from the Roth 401(k)? Start here!

Why Roth?

Both the Roth IRA (individual retirement account) and the Roth 401(k) offer the same unique tax advantages. With a traditional IRA or 401(k), tax advantages come immediately—the money you deposit into the account is pre-tax dollars, so it reduces your tax obligations. However, when you take out money in retirement, withdrawals are taxed.

With a Roth IRA or Roth 401(k), it’s exactly the opposite. Money is taxed before it goes into the account—but when it’s withdrawn, there’s no tax obligation. This makes any Roth account a good option for people who foresee being in a higher tax bracket in the future. It’s why Roth accounts are so popular amongst young people just starting out in their career. But, Roth has advantages for older adults as well. Depending on income, it’s possible that withdrawals during retirement could push you into a higher tax bracket—making it more advantageous to take care of your tax obligation up-front.

One important point to remember is that the Roth tax advantages only apply to qualified distributions, meaning that at the time you withdraw money from your retirement account, you’ve surpassed a certain age (59½) and held the account for a certain number of years (five).

Roth IRA vs. Roth 401(k)

While the Roth IRA and Roth 401(k) are similar in how they confer tax advantages, these two retirement savings accounts have a few key differences:

  • Income limits: To open a Roth IRA, you must earn a yearly income of less than $140,000 per year as an individual taxpayer, or $208,000 for married couples filing together. These income limits exclude higher earners from putting their retirement savings in a Roth IRA. On the other hand, the Roth 401(k) has no income limitation to participate—so it’s a great option for taxpayers in a higher bracket.
  • Contribution limits: In a similar vein, the Roth IRA only allows for $6,000 to be contributed per year, or $7,000 if you’re 50 years of age and older. The Roth 401(k), on the other hand, has an annual maximum contribution of $19,500 if you’re under 50 and $26,000 if you’re 50 or older.
  • Set-up: An employer must set up a Roth 401(k) for you. With a Roth IRA, you’ll need to set this up yourself, or have a financial professional do it for you. Keep in mind that as with any retirement account, there are two steps—moving your money into the account, and deciding where to invest it.
  • Investments: With a Roth IRA, you can invest your retirement savings in the financial product of your choice; whether that’s bonds, specific stocks, a target-date mutual fund, and so on. With a Roth 401(k), your investment options depend on the plan provider your employer is working with. There may be a wide variety of investment vehicles to choose from, or you could be limited to a more narrow selection.
  • Distributions: The Roth 401(k) requires that you start taking mandatory contributions at age 72, whereas with a Roth IRA, there’s no age threshold. This means you can let your investments grow for a longer period, if you wish.

Final Thoughts

Keep in mind that the Roth IRA and Roth 401(k) aren’t mutually exclusive. It’s completely fine to hold both accounts at the same time, and be making maximum contributions to each. Whatever retirement savings strategy you choose, remember to chat with a financial expert if you have any questions or concerns about how best to invest your money and save for the future. For a 401(k) plan you should be able to direct questions to your workplace’s HR department, and for an IRA, you can get in touch with someone at your financial institution who has expertise on investing and retirement strategies.

Tags: Retirement