The Difference Between a Roth 401k and a Roth IRA

The Difference Between a Roth 401k and a Roth IRA

| March 07, 2024

When it comes to retirement planning, one of the key decisions individuals face is choosing how they want to save. Oftentimes, this comes down to choosing between a Roth 401k and a Roth IRA. While both offer tax-free growth and withdrawals in retirement, there are significant differences between the two that can impact your overall retirement strategy.


The Basics

Firstly, let's break down the basics. A Roth 401k is a retirement savings account offered by employers as part of their retirement benefits package. Contributions to a Roth 401k are made with after-tax dollars, meaning you pay taxes on the money before it goes into the account. On the other hand, a Roth IRA is an individual retirement account that you can open on your own through a brokerage firm or financial institution. Contributions to a Roth IRA are also made with after-tax dollars.


The Differences

One key difference between the two lies in contribution limits. Roth 401k contribution limits are higher than those for Roth IRAs, allowing you to potentially save more for retirement through your employer-sponsored plan. Currently the maximum contribution if you’re under 50 is $23,000 for a Roth 401k or $7,000 for a Roth IRA and these numbers increase if you’re older than 50. Additionally, Roth 401k contributions may allow for employer matching contributions, providing an extra incentive to save. Furthermore, the Roth 401k may only allow you to invest in options given by the 401k provider, whereas a Roth IRA gives you the opportunity to choose from a much wider range of investments.


Another important distinction is eligibility. While Roth IRAs have income limits that may restrict high earners from contributing directly, Roth 401ks have no income limits, making them accessible to individuals regardless of their income level.

Finally, withdrawal rules differ between the two. With a Roth 401k, you may be subject to required minimum distributions (RMDs) once you reach age 73, whereas Roth IRAs do not have RMDs during the account holder's lifetime, allowing for more flexibility in retirement planning and tax management. It’s worth noting once you separate from your company you will be able to rollover the Roth 401k into a Roth IRA and avoid the RMD rules.


Conclusion

In summary, while both Roth 401ks and Roth IRAs offer valuable tax advantages, understanding their differences and considering your individual financial situation and retirement goals is crucial in making the best decision for your future. Consulting with a financial advisor can also provide personalized guidance tailored to your specific needs. If you want to talk with a financial planner about putting together your plan moving forward, please call our office at (734) 681-7575 or email me directly at preston@peakwm.com.