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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 reduce taxable income in the year you make the contribution as long as you meet IRS guidelines.
The Roth was introduced in 1997, the year my second son was born; during that time, I had a busy schedule that did not include planning portfolio and tax strategies for my retirement.
Recently, 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) (and fund any shortfalls in take-home income by selling shares of a concentrated holding). 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:
- Contributions to a Roth IRA or Roth 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:
- There are no required minimum distributions (RMDs) for Roth IRAs but there are RMDs for Roth 401(k) plans
- The maximum of an annual Roth IRA contribution is $5,500 plus $1,000 in catch-up contributions for those who are 50 and over, but there may be additional restrictions based on income
- The annual contribution limit for a Roth 401(k) is $18,000 plus $6,000 in catch-up contributions for those 50 and over
- You can fund a Roth IRA for your spouse with your income but generally 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.
- There may be rules associated with your Roth 401(k) plan established by your employer in addition to IRS regulations
A Roth 401(k) can be rolled over into a Roth IRA. Still, while saving for retirement, it's important to know the differences between the two types of accounts.
Did you know that the Roth IRA is different than the Roth 401k? Have you funded a Roth account?