Roth IRA Vs. Roth 401(k): What Are The Differences?

For quite a while my workplace has only offered a 401(k) plan for employees to invest in, and the investment options in the plan were pretty limited.  Because of that, and the fact that there was no company match on invested dollars, we’ve been investing through other vehicles, like the Roth IRA.

Within the past couple of months our company has switched plan administrators, and in the process the company plan has opened up a whole new slew of investment options.  While the company still isn’t matching contributions, I was pleasantly surprised to find that they are now offering a new Roth 401(k) plan.

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If you’ve been reading this site for any amount of time you know that I’m a big fan of the Roth IRA, so having a Roth 401(k) option is something I’m pretty pumped for.   But I did have a few questions, including – how are the Roth IRA and the Roth 401(k) different, and does either of them have benefits over the other?

Roth IRA Vs. Roth 401k

Contribution Amounts For Roth IRA Vs. Roth 401(k)

One of the biggest differences between the two account types is that their contribution limits vary by quite a bit.

  • Roth IRA contribution limit: The Roth IRA currently has a contribution limit of $5,500, with an allowed $6,500 contribution limit if you’re 50 or over.
  • Roth 401(k) contribution limit: The Roth 401(k) has a higher contribution limit of $17,500/year, with a 50+ contribution limit of $23,000.

So if you’re looking at contribution limits the Roth 401(k) has a definite advantage because you can contribute $12,000 more per year than with a Roth IRA.

Required Minimum Distributions

Quite often retirement accounts like the 401(k) will require that investors take a required minimum distribution from their account balance once they reach a certain age.  The Roth 401(k) is no different with the account type requiring you take minimum distributions starting at age 70 1/2.   If you need to be taking money out of the account anyway, that probably isn’t going to be a big deal.  If however, you would prefer to allow the balance to continue to grow without taking distributions the Roth IRA is probably the better choice.  The Roth IRA account can essentially exist forever without requiring you to take distributions, and can be passed down.

Some have suggested that if you don’t anticipate needing to take distributions from your account upon retirement, that you roll your Roth 401(k) over into a Roth IRA when leaving an old job.  That way you won’t have to take RMD.

Investment Options Available

Quite often when you’re working with an employer sponsored retirement plan your investment options are going to be limited to the few options that are made available by your plan administrator.  Depending on what investment options are available that may mean you’re not able to invest how you might like.

The Roth IRA, however, doesn’t limit your options and you can invest in pretty much whatever you’d like, including individual stocks and bonds.

Luckily for me my company’s new Roth 401(k) plan offers a good range of solid index funds for me to invest in, so this isn’t an issue for me.   If, however, you’re limited in your own Roth 401(k) and there is no company match, you may want to start by investing in your Roth IRA first.

Company Matching Investments

One thing that is nice about the Roth 401(k) is that you can receive a company match when contributing to that account type.    The same can’t be said for the Roth IRA since it isn’t a company sponsored plan type.

If you are receiving a company match when contributing to a Roth 401(k), your account will have to have a traditional 401(k) component built onto it since company  matching funds have to be done pretax.   If you are getting a company match I highly recommend contributing to your Roth 401(k) first as it is essentially an instant 100% return on your investment!

Income Limits

The Roth IRA has income limits attached to it, with high income individuals and couples having contributions phased out completely at $127,000 and $188,000 AGI respectively.   Contribution amounts begin phasing out at $112,000 and $178,000 respectively.   So if you’re making more than those amounts you may not be able to contribute to a Roth IRA.

The Roth 401(k) on the other hand doesn’t have those income limits.  High income individuals can contribute to a Roth 401(k) without regards to their adjusted gross income.

Is A Roth IRA Or Roth 401(k) Better For Me?

Depending upon what your current situation is, either one of the account types may fit your situation best.  Things you’ll need to take into account include your current income levels, whether your company has matching contributions, what kind of investment options are available in your company’s Roth 401(k) and how much you’re looking to invest.  Future tax rates and how long you have to invest might play into it as well.

Depending on your situation you may choose to invest in one or both of these account types, and even diversifying your tax situation by investing in a Traditional IRA or 401k as well.   For us, we’re currently investing in both our pretax 401k and our post-tax Roth 401k, as well investing a bit in our Roth IRA.  We’re covering all the bases!

How about you? Are you investing in one or both of these account types? Does your company offer a match?  Have you considered the differences between the account types – and has it affected how you invest? Tell us your thoughts in the comments!

Last Edited: 23rd January 2013

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  1. Kelly O'Connor says

    Sounds great…as long as the government doesn’t change the rules. What is the lowest-hanging-fruit for them right now? Qualified Plans. They completely “own the pen” on these accounts…they designed it that way. What if you could have all the benefits and more as well as the government having no ability to change the rules on you, would be interested?

  2. says

    Taxes – You put money into a 401k before it gets taxed, but you pay taxes when you withdraw from your 401k. You put money into a Roth IRA after it has already been taxed BUT you can withdraw the money tax free. So if you think your tax rates are going up (and they probably are), a Roth IRA can make a lot of sense.

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