All Roth plans — IRA and 401(k) — are funded with after-tax dollars. Another commonality is that when you retire, you can withdraw the initial contribution amount as well as any gains tax-free. In addition to these benefits, Roth 401(k) plans have the following advantages over Roth IRAs:
- No income limits: Roth IRA contributions can only be made by those with annual 2022 income of less than $144,000 (or $214,000 if your tax status is married filing jointly). In contrast, Roth 401(k) contributions are open to all employees no matter their income.
- Higher contribution limits: Roth IRA contribution limit is $6,000 for 2022 (or $7,000 for those aged 50 or older). In contrast, Roth 401(k) has a contribution limit of $20,500 (or $27,000 if over 50).
- Employer matching: Many employers offer matching contributions for not only traditional 401(k) contributions but also any contributions made to Roth 401(k). One caveat is that the employer's matching contributions are deposited in the traditional 401(k) bucket. So, unlike the employee contributions to Roth 401(k), employer matches are not tax-free upon distribution in retirement.
The drawbacks of Roth 401(k) compared to Roth IRA are:
- Required minimum distributions: Starting at the age of 72, it is mandatory to take money out of your Roth 401(k) according to IRS guidelines. These RMDs (required minimum distributions) are calculated based on the account balance and IRS-supplied life expectancy charts. For savvy investors who do not want to take these distributions, there is a loophole. They can avoid RMDs by rolling over the Roth 401(k) into a Roth IRA when they quit their job. Funds that have been in a Roth IRA for more than 5 years are not subject to minimum distribution requirements.
- Limited investment options: IRAs are typically like regular brokerage accounts, with the options to invest in any stocks, bonds or even options for experienced investors. In contrast, 401(k)—including Roth 401(k) plans—usually offer a very limited set of investment options. Typically these are target retirement date funds, or index funds that track the S&P 500.
|Roth 401(k)||Roth IRA|
|Plan set by||Employer||Individual|
|Contribution Limits||2018: $18.5K (under 50 yrs old), $24.5K (50+); 2014: $17.5k (under 50), $23K (50+); limits apply to combined total contributed to 401(k) and Roth 401(k). Employee and employer combined contributions must be lesser of 100% of employee's salary or $53K||$5,500/yr for age 49 or less; $6,500/yr for age 50+; limit is for combined contributions to traditional IRA and Roth IRA.|
|Income Limits||None||Based upon MAGI; Single, HoH, MFS: full contrib to $117,000, partial to $132,000; MFJ; QW: full contrib to $184,000, partial to $194,000. Can't contribute more than you earn in that year.|
|Employer contributions||No. Some employers offer matching contributions but they must be allocated into a pre-tax account, like a traditional 401(k).||No|
|Investments in the account||Stocks, Bonds, Mutual Funds. Capital gains, dividends, and interest within account incur no tax liability.||Stocks, Bonds, Mutual Funds, Real Estate (Only in specific types of IRA's). Capital gains, dividends, and interest within account incur no tax liability.|
|Tax Implications||Money set aside for Roth 401k is taxed, but once saved in the account, grows tax-free and is not subject to tax at withdrawal.||Contributions are never tax-deductible. Gains in the account are not taxed. Distributions from the account are tax-free.|
|Distributions||Distributions can begin if 2 conditions are met: (1) the earliest contribution to the account was at least 5 years ago, and (2) owner is over age 59 1/2 or becomes disabled.||Distributions can begin at age 59½ as long as the account is at least 5 years old; or if owner becomes disabled.|
|Forced Distributions||Must start withdrawing funds at age 70 1/2 unless employee is still employed.||No such restrictions or forced distributions.|
|Borrowing against Account||Depending upon the plan, borrowing against funds in the account is allowed up to 50% of the account value but only if still employed with the same employer.||No|
|Early Withdrawal||No penalties as long as workers don't tap into their investment gains. Tax-free withdrawals for people over age 59 1/2 begin after they've had their account for at least five years||No penalties on early withdrawal up to the amount of principal contribution.|
|Early Withdrawal for Medical Expenses||Taxable portion of medical expenses not covered by insurance for employee, spouse, or dependents subject to 10% penalty. At times, the penalty is waived depending on the employer as well as seriousness of the illness.||Can withdraw for qualified unreimbursed medical expenses that are more than 7.5% of AGI; medical insurance during period of unemployment; during disability|
|Early Withdrawal for Homebuyers||Taxable portion of purchase of first home and avoidance of foreclosure or eviction of primary residence is subject to 10% penalty.||Can withdraw (without the 10% tax penalty) up to $10,000 for a first time home purchase down payment with stipulations|
|Early Withdrawal for Educational Expenses||Taxable portion of payment of secondary educational expenses in last 12 months for employee, spouse, or dependents subject to 10% penalty.||Can withdraw for qualified unreimbursed medical expenses that are more than 7.5% of AGI; medical insurance during period of unemployment; during disability|
|Conversions||Can be rolled to Roth IRA.||A Roth IRA cannot be converted into a traditional IRA.|
|Withdrawals||Not taxed, assuming qualified withdrawals in retirement.||Tax free|
|Changing Institutions||Can rollover to another employer's Roth 401(k) if offered, or to a Roth IRA independently, but not back to a traditional 401(k)||Funds can be either transferred to another institution or they can be sent to the owner of the traditional IRA who has 60 days to put the money in another institution in a rollover contribution to another traditional IRA.|
Video explaining the differences between Roth 401(k) and Roth IRA