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The Roth IRA and its counterpart the Roth account within a 401k plan offer attractive and unique benefits to retirement savers and retirees: contributions grow tax-free and qualified withdrawals are not subject to income tax.
Though I love the concept of the Roth, funding such an account has not been simple. Income must fall under IRS thresholds plus you must have the cash needed to make a contribution. In addition, its advantages must be weighed against the benefits of traditional IRAs, which generally reduce taxable income in the year you make the contribution.
My Struggles and Triumphs with Funding Roth Accounts
When I started saving for retirement, the Roth account didn't exist. When the Roth was introduced in 1997, I had a baby and young child. My schedule did not include planning portfolio and tax strategies for my retirement. When I was ready to build my Roth assets, our income often exceeded thresholds because of capital gains from selling stock to diversify our portfolio.
A few years ago, my husband's employer started offering the Roth designation in its 401(k) plan. So, rather than mess with the Roth IRA, we decided to max out contributions to the Roth 401(k), which means this account is funded with $25,000 annually consisting of regular and catch-up contributions ($19,000 + $6,000). That's a lot of money to set aside for retirement so we fund any short-falls in take-home income and expenses by selling shares from a former employer's stock plan. This move allows us to both diversify and boost our Roth account balances.
Now that I have a Roth IRA and a Roth 401(k), I have discovered that though they have similarities, they also have differences. Here is what I have learned:
Similarities of Roth IRAs and Roth 401(k)s
- Contributions to a Roth IRA or Roth designated account in a 401(k) plan are not deducted from income in the year that I make the contribution
- Investments inside the account grow tax-free; investment gains, dividends, and interest are not taxed when held in both types of Roth accounts
- Distributions or withdrawals are not included in income tax
- I may be able to withdraw funds from a Roth account without incurring a tax liability if I follow certain guidelines and only take out contributions, not earnings
Differences between Roth IRAs and Roth 401(k)s
- There are no required minimum distributions (RMDs) for Roth IRAs but there are RMDS for Roth 401(k) plans; however you can roll the Roth 401(k) into a Roth IRA and avoid RMDs in retirement
- The maximum of an annual Roth IRA contribution is $6,000 plus $1,000 in catch-up contributions for those who are 50 and over, but there are additional restrictions based on income; the annual contribution limit for a Roth 401(k) is $19,000 plus $6,000 in catch-up contributions for those 50 and over
- You can fund a Roth IRA for your spouse but you can't fund a Roth 401(k) for your spouse
- Generally, I can pick the investments I want to include in a Roth IRA but I need to choose from a menu of investment choices for the 401(k) plan
- Roth IRA rules are generally standard but your employer may have its own set of rules for your Roth 401(k) plan in addition to IRS regulations
If you can't contribute to a Roth IRA because of income restrictions, then the Roth designated account within a 401(k) could be a great way to boost your tax-free holdings in retirement. There are slight differences but the main idea of paying more in taxes now, less later holds for both.
Did you know that the Roth IRA is different than the Roth 401k? How have you funded a Roth account?