A Roth 401(k) and a Roth IRA sound similar — and they are. Contributions are made after taxes, and earnings can be taken out tax-free at age 59 1/2. But the Roth 401(k) has a few key differences from the Roth IRA.
1. Contribution amounts
The most distinguishing characteristic of 401(k)s, whether Roth or traditional, is the high contribution limit, allowing employees to save up to $18,000 per year. For workers over 50, the ceiling is $24,000. The limit for 2018 increased to $18,500, and $24,500 for workers over 50.
Meanwhile, IRA contribution limits are $5,500, and workers over 50 may contribute up to $6,500 per year.
A benefit of the Roth IRA is that the account can exist, essentially, forever without any minimum required distributions.
“The Roth IRA can be passed down to the next generation and provide tax-free earnings for that generation and the next,” says Dean Barber, founder and president of Barber Financial Group.
A Roth 401(k), on the other hand, will require distributions starting at age 70 1/2. If you need the money, you may not mind taking the distributions. But there is a way around it if you prefer to keep your savings working for you tax-free. In that case, account holders can roll the account over from a Roth 401(k) to a Roth IRA.
3. The match in a Roth 401(k)
Besides their high contribution limits, Roth 401(k)s have another advantage: The worker’s contributions can be matched by the employer up to a certain percentage. It’s essentially free money from the employer, on top of the employee’s elective deferrals.
However, if you are contributing to a Roth 401(k), the match portion of the contribution will be treated as a traditional 401(k) contribution because it goes in pretax.
“The employer part never reaches you, so it can’t be done on an after-tax basis,” Barber says. “The match from the employer can’t be taxed, so it can’t be a Roth.”
That means that every Roth 401(k) account essentially has a traditional component if the employer provides matching contributions.
For workers who divide contributions between a regular 401(k) and a Roth 401(k), the company match will be applied to the traditional 401(k).
4. Investment options
A Roth IRA allows investors a great deal more control over their accounts than a Roth 401(k). Investors can choose from the universe of investments for their own accounts, including individual stocks and bonds, but are limited to the funds their employers offer in a 401(k) plan.
Depending on their plan’s investment menu, employees might be better off maximizing the match from their employer and then funneling extra retirement dollars into a Roth IRA. That way they can take advantage of better investment options if the fund lineup is too limited in the employer’s plan.
5. Income limits
Roth IRA contributions are off-limits if your modified adjusted gross income in 2017 is $196,000 or more for married couples filing jointly or $133,000 or more for single filers.
Meanwhile, there are no income limits on Roth 401(k)s.