Retirement | May 5, 2022

Roth 401(k) vs. Roth IRA

According to the Plan Sponsor Council of America, Roth 401(k)s are now permitted for nearly 90% of retirement plans. If your employer is among them, you may be wondering how a Roth 401(k) differs from a Roth IRA.

 “Both Roth IRAs and Roth 401(k)s are funded with after-tax dollars—meaning there’s no upfront tax benefit for contributing—but once you get to retirement, you can withdraw the contributions and earnings totally tax-free,”1 says Hayden Adams, CPA, CFP®, director of tax and financial planning at the Schwab Center for Financial Research. “However, Roth 401(k)s offer additional benefits that should not be overlooked.” Chief among them:

  •  No income limits: Anyone can contribute to a Roth 401(k), if available, regardless of income level. In contrast, only individuals earning less than $144,000 in 2022—$214,000 for married couples—can contribute to a Roth IRA. “Higher earners often access Roth IRAs by converting their traditional IRAs, but doing so can trigger a big tax bill,” Hayden says. “Saving in a Roth 401(k) could be a better way to go if the taxes on a Roth IRA conversion are prohibitive.”
  • Higher contribution limits: In 2022, you can stash away up to $20,500 in a Roth 401(k)—$27,000 if you’re age 50 or older.2 Roth IRA contributions, by comparison, are capped at $6,000—$7,000 if you’re 50 or older.
  • Matching contributions: Roth 401(k)s are eligible for matching contributions from your employer, if offered. That said, your employer’s matching contributions are pretax and will be placed in a regular, tax-deferred 401(k) account, which means you’ll be taxed once you start taking distributions.

 One potential disadvantage of using a Roth 401(k)—at least relative to a Roth IRA—is that you’ll have to take IRS-mandated required minimum distributions (RMDs) starting at age 72. To avoid these mandatory distributions and keep your money invested, once you leave your job you can roll over your Roth 401(k) into a Roth IRA, which aren’t subject to RMDs.3 Another drawback is that you’ll be limited to the investments offered by your company’s plan instead of the variety available with a Roth IRA from a brokerage. Investment fees may also be higher.

“Nevertheless, Roth 401(k)s can still be a great tool—especially for high-wage earners and/or those who anticipate higher taxes in retirement,” Hayden says.

Account holder must be 59½ or older and have owned the account for at least five years.

You may choose to split your contributions between Roth and traditional 401(k)s, but your combined contributions can’t exceed $20,500 ($27,000 if you’re age 50 or older).

Be aware that the five-year rule applies to the length of time the Roth IRA has been open, regardless of how long the Roth 401(k) was open.

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