How a Roth 401(k) is Different than a Roth IRA - Ed Slott and Company, LLC (2024)

FAQs

How a Roth 401(k) is Different than a Roth IRA - Ed Slott and Company, LLC? ›

Roth 401(k)s do not have any income limits on contributions. If you are a high earner, you will still be able to make deferrals. That is not the case for Roth IRAs. In 2023, your ability to contribute to a Roth IRA will begin to phase out when your income exceeds $138,000 ($218,000 if you are married, filing jointly).

With a Roth IRA, you generally have a large number of investments to choose from, including stocks, bonds, cash alternatives, and alternative investments. With a Roth 401(k), you are limited to the investment options offered by your employer's 401(k) plan.

If you are looking to offer your employees a retirement plan and make matching contributions (as part of their benefits package), consider a Roth 401(k) plan. Since a Roth IRA plan is an individual account, you are not able to make matching contributions.

Both are great tax-advantaged savings options so invest in both if you can manage the contributions. If your employer offers a retirement plan at work (especially with matching contributions), be sure to enroll in that. Then you can decide to open a personal Roth IRA, based on how much you earn.

The contribution limits are the same for Roth and traditional versions of 401(k)s and IRAs. One financial strategy, for those who want to maximize their tax-advantaged savings: Open both types of Roth accounts. You can invest up to the combined allowable limits in a Roth 401(k) and a Roth IRA.

Roth 401(k)s reduce taxes later

However, the Roth 401(k) earnings aren't taxable if you keep them in the account until you're 59 1/2 and you've had the account for five years. Unlike a tax-deferred 401(k), contributions to a Roth 401(k) do not reduce your taxable income now when they are subtracted from your paycheck.

In the case of a Roth 401(k), you contribute with after-tax dollars. So, your employer would include your contributions in box 1 from your W-2. Whether you own a traditional or Roth 401(k), as long as you didn't take out any distributions, you don't have to do a thing on your federal or state return!

“If you open a Roth IRA for the first time in order to receive Roth 401(k) rollover funds, then you must wait five years to take a distribution penalty-free.” This rule wouldn't prevent you from withdrawing your original contributions after the rollover is complete.

The majority of large employers offer a Roth 401(k) retirement plan option, but not many employees choose it. There are pros and cons to choosing a Roth 401(k), and the right answer for you will depend on your own financial circ*mstances and preferences.

If you participate in an employer's retirement plan, such as a 401(k), and your adjusted gross income (AGI) is equal to or less than the number in the first column for your tax filing status, you are able to make and deduct a traditional IRA contribution up to the maximum of $7,000, or $8,000 if you're 50 or older, in ...

Why a Roth 401k is better? ›

The Roth 401(k) holds the advantage because tax-free growth and withdrawals in retirement mean your savings won't be affected by future tax rates (since they've already been taxed). Both Roth and traditional 401(k) contribution limits are currently set at $23,000 ($30,500 if you're over the age of 50) for 2024.

A backdoor Roth IRA is a conversion that allows high earners to open a Roth IRA despite IRS-imposed income limits. Basically, you put money you've already paid taxes on in a traditional IRA, then convert your contributed money into a Roth IRA, and you're done.

Roth IRA contribution limits for 2024

The Roth IRA contribution limit for 2024 is $7,000 for those under 50, and an additional $1,000 catch up contribution for those 50 and older. Source: "401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000," Internal Revenue Service, November 1, 2023.

The Roth IRA five-year rule says you cannot withdraw earnings tax-free until it's been at least five years since you first contributed to a Roth IRA account. This five-year rule applies to everyone who contributes to a Roth IRA, whether they're 59 ½ or 105 years old.

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.

Should You Split Contributions Between a Roth and Traditional Account? Splitting contributions between a Roth and traditional account can allow you to get some tax benefit today while hedging somewhat against higher tax rates in the future.

By converting to a Roth IRA, you'll have assets that won't be taxed when withdrawn, potentially allowing you to better manage your tax brackets and enable more personalized tax planning during retirement.

The biggest benefit of the Roth 401(k) is this: Because you already paid taxes on your contributions, the withdrawals you make in retirement are tax-free. That's right! The money you put in—and its growth! —is all yours. No taxes will be taken out when you use that money in retirement.

It can be a surprisingly complicated choice, but many experts prefer the Roth 401(k) because you'll never pay taxes on qualified withdrawals. Contributions are made with pre-tax income, meaning you won't be taxed on that income in the current year.