An In Depth Guide: Roth 401(k) vs Roth IRA

According to Becker’s Hospital Review, 74 percent of doctors are either corporate or hospital employees. As of a 2021 study, around 24% of community hospitals in the U.S. were classified as for-profit. Most for-profit employers offer their employees some type of retirement savings plan, with 94% offering a traditional 401(k) plan and 68% offering a Roth 401(k) plan.

Roth IRAs and Roth 401(k) accounts are two types of retirement savings accounts that offer tax advantages to investors. While they share some similarities, they also have some distinct features.

Which is better for you: Roth 401(k) or Roth IRA? Let’s take a look.

Key Takeaways

• Roth IRAs and Roth 401(k)s are two types of retirement savings accounts that allow you to make contributions towards your retirement savings and make investments on a self-directed basis.
• Roth IRAs allow for tax-free growth and withdrawals, have lower contribution limits, and have income limits for making eligible contributions.
• Roth 401(k) accounts are an employer-sponsored plan that allows for higher contribution limits and may include employer matching.
• Both Roth IRA and Roth 401(k) contributions are made with after-tax dollars, meaning there’s no tax deduction in the years you contribute.
• The choice between a Roth IRA and a Roth 401(k) will depend on your individual circumstances and retirement goals.

Before we look into the difference between a Roth 401(k) and a Roth IRA, let’s see how traditional 401(k)s and traditional IRAs work.

What is a Traditional IRA?

Traditional IRAs are individual retirement accounts that, similar to 401(k) plans, allow you to contribute pre-tax money to different investments.

Unlike 401(k) plans, IRA accounts are not employer-sponsored, and individuals can establish an account anytime. Also, with IRA accounts, you’re not limited to a defined set of investment options as you would through an employer-sponsored plan such as a 401(k) plan.

With a traditional IRA, investments are contributed on a pre-tax basis. The money grows tax-deferred until it is withdrawn in retirement, when your withdrawals are taxed as ordinary income.

As of 2023, you can contribute a maximum of $6,500 annually to traditional IRA accounts. If you are 50 or older, you’re eligible for an additional catch-up contribution of $1,000.

In 2024, the contribution limit will be $7,000; if you are 50 or older, the additional catch-up contribution limit remains at $1,000.

What is a Traditional 401(k) Plan?

A traditional 401(k) plan is a retirement savings plan offered by for-profit institutions that allows employees to put away a portion of their salary into a tax-advantaged retirement account for investments.

Employees who sign up for a traditional 401(k) agree to have a percentage of their paycheck paid directly into the investment account. The employer may match part or all of that contribution.

With a traditional 401(k), employee contributions are pre-tax, reducing your taxable income, but your withdrawals are taxed. This means the money comes from your paycheck before income taxes are deducted. In this way, your taxable income is reduced by the total contributions you make for the year.

Your employer will report your taxable income as part of your W-2, so there is no need to track or manually deduct your 401(k) contributions from your annual wages. No taxes are due on the money contributed or the investment earnings until you withdraw the money, typically in retirement.

As of 2023, the contribution limit for traditional 401(k) plans is $22,500. If you are 50 or older, you’re eligible for an additional catch-up contribution of $7,500 for a maximum contribution limit of $30,000.

In 2024, the contribution limit will be $23,000, and if you are over 50 or older, you’re eligible for an additional catch-up contribution limit of $7,500 for a maximum contribution limit of $30,500.

Understanding Roth 401(k)s and Roth IRAs

What is a Roth IRA?

A Roth IRA is an individual retirement account that allows you to set aside after-tax income up to a specified amount each year. The money you contribute to a Roth IRA comes from earned income you’ve already paid taxes on.

Unlike with a traditional IRA, you don’t get an upfront tax break. But the main benefit of a Roth IRA is that your contributions and the earnings on those contributions grow tax-free and can be withdrawn tax-free in retirement.

As with a traditional IRA, there are limits to the amount of money that an investor can contribute to a Roth IRA per year. For 2023, you can contribute up to $6,500 per year. And if you’re 50 or older, you’ll be eligible for an additional catch-up contribution of $1,000, limiting the total contribution limit to $7,500. Also, your contributions may be limited by your income, as we’ll explain below.

In 2024, the contribution limits for Roth IRAs will be $7,000. And if you’re 50 or older, you’ll be eligible for an additional catch-up contribution of $1,000, making the total contribution limit $8,000.

Unfortunately, the income limits set for Roth IRAs often exclude high-income earners such as doctors from making contributions. For 2023, the Modified Adjusted Gross Income (MAGI) limits to make eligible Roth IRA contributions are:

• If you’re single, head of household, or married, filing separately (and did not live with your spouse at any time during the year), you can contribute up to the limit if your modified adjusted gross income (MAGI) is less than $138,000. If your MAGI is between $138,000 and $153,000, you can contribute a reduced amount. If your MAGI is more than $153,000, you cannot contribute.

• If you’re married, filing jointly, or a qualifying widow(er), you can contribute up to the limit if your MAGI is less than $218,000. If your MAGI is between $218,000 and $228,000, you can contribute a reduced amount. If your MAGI is more than $228,000, you cannot contribute.

• If you’re married, filing separately, and living with your spouse at any time during the year, you can contribute a reduced amount if your MAGI is less than $10,000. If your MAGI is more than $10,000, you cannot contribute.

What is a Roth 401(k)?

A Roth 401(k) is an employer-sponsored retirement savings account where contributions are made with after-tax dollars. This means you pay taxes on your income before contributing to your Roth 401(k). However, your money grows tax-free, and you don’t have to pay taxes when you make qualified withdrawals.

Withdrawals from a Roth 401(k) are tax-free if they are considered “qualified withdrawals.” A withdrawal is considered qualified if it meets both conditions below:

• It occurs at least five years after the tax year in which you first made a Roth 401(k) contribution
• It’s made after you turn 59 1/2

The availability of Roth 401(k) plans among employers has been increasing over the years. As of 2021, about 88% of 401(k) plans offer a Roth 401(k) option in addition to the traditional 401(k) option.

Roth 401(k) vs Roth IRA: Key Differences

Income Restrictions

Roth 401(k)s have no income limits. In contrast, Roth IRAs have an upper limit for how much you can earn in a year and still make contributions. Unlike the Roth 401(k), which has no income limits, Roth IRAs have an upper limit for how much you can earn in a year and still make eligible contributions.

One way to overcome the Roth IRA contribution limit is by using a strategy calledMega Backdoor Roth. This strategy enables high earners to contribute to a Roth IRA or Roth 401(k) by using after-tax 401(k) contributions up to the annual contribution limit in their 401(k) plan.

After-tax contributions refer to the amount of money you contribute to a 401(k) after you’ve reached your 401(k) employee contribution limit. These contributions are made with after-tax dollars so that they won’t reduce your taxable income.

In simple terms, the Mega Backdoor Roth strategy involves two steps:

Step #1: Make an after-tax contributions to your 401(k) plan after you’ve reached your 401(k) employee contribution limit.

Step #2: Convert these contributions to a Roth IRA or Roth 401(k) through an in-service rollover or in-plan conversion.

An in-service rollover or in-plan conversion is rolling over funds from an active 401(k) plan to an IRA while you’re still employed. Note that not all plans offer after-tax contributions or in-service rollovers, or in-plan conversions, so you’ll need to check with your plan administrator.

Employer Match

Roth IRA accounts don’t have an employer matching feature. However, many employers who offer 401(k) plans also provide contribution matching programs.

If your employer offers a 401(k) matching program, they will match your contributions to your Roth 401(k) up to a specific limit.

This means that while your contributions to a Roth 401(k) can be withdrawn tax-free in retirement, any employer-matching contributions and their earnings are placed in a separate, regular 401(k) account and will be subject to income tax upon withdrawal.

Also, note that employer contributions might have vesting schedules that employees must fulfill before gaining complete ownership of those funds. A vesting schedule is a period of time you must work for your employer before fully owning the employer-contributed funds in your 401(k) account.

Tax Treatment and Scenarios

• Neither Roth 401(k) nor Roth IRA accounts provide an immediate tax deduction, but both accounts offer tax-deferred growth and tax-free withdrawals in retirement. Both accounts have the same tax treatment of contributions and withdrawals.

With both of these accounts, you are making after-tax contributions. Since the money contributed has already been subject to income tax, your withdrawals during retirement (including the earnings on your contributions) are tax-free as long as you’ve reached the age of 59 1⁄2 and the account has been open for at least five years.

Let’s look at two scenarios:

Scenario A – Roth 401(k) and or Roth IRA with Expectation of High Tax Bracket in Retirement: 

If you’re early in your career and expect your income (and therefore tax rate) to increase over time, a Roth 401(k) and or Roth IRA could be beneficial over a regular 401(k) and or traditional IRA.

With the Roth accounts, you pay taxes now when your income is lower. Plus, if there are years when your income will be lower for specific reasons (e.g., working part-time or being laid off), it could be more favorable to contribute to a Roth 401(k).

Scenario B – Regular 401(k) with Expectation of High Tax Bracket Now: 

If you’re later in your career and already in a high tax bracket, a regular 401(k) or traditional IRA might be more advantageous. Your contributions lower your taxable income now when it’s higher. However, if you expect to be in a high tax bracket during retirement, withdrawals from these plans could result in more taxes.

Withdrawal Rules

Money in a Roth 401(k) and Roth IRA account grows tax-free and can be withdrawn tax-free in retirement. The rules for withdrawing from a Roth account are as follows:

• You can begin withdrawing funds from your Roth without penalty once you reach age 59 1⁄2
• If you withdraw funds before age 59 1⁄2, you may be subjected to early withdrawal penalties, though certain exceptions are permitted, such as if you become permanently disabled.
• Qualified withdrawals, which are not subject to tax or penalty, occur after you reach 59 1⁄2 and have held the Roth account for at least five years.
• Non-qualified withdrawals from a Roth are subject to income tax and a 10% penalty on the earnings portion of the withdrawal.

Investment Options

Your employer decides all investment options for your 401(k) plan. In contrast, a Roth IRA allows investors to contribute to investments on a self-directed basis, offering more investment choices.

Roth IRAs offer the flexibility of self-directed investing, which opens up a wide range of investment possibilities. This includes individual stocks, bonds, mutual funds, and exchange-traded funds (ETFs), providing you with diverse assets.

In comparison, your Roth 401(k) plan typically offers a preselected menu of investment options, such as various types of mutual funds or ETFs, and your contributions are invested into those you choose at specific amounts you set.

If you want more control over your investments and access to a broader selection of assets, contributing to a Roth IRA account can provide that flexibility.

Required Minimum Distribution (RMD) Rules

Roth IRAs are not subject to RMD rules until the owner dies. In contrast, Roth 401(k) accounts are subject to the Required Minimum Distributions (RMD) rules, but only for the years 2022 and 2023.

Most retirement accounts are subject to Required Minimum Distributions (RMD). RMD rules require individuals to start taking money from tax-deferred accounts like 401(k)s and IRAs starting at age 72.

Roth 401(k) accounts are subject to the Required Minimum Distributions (RMD) rules, but only for 2022 and 2023. From 2024 onwards, the RMD rules will no longer apply to designated Roth accounts.

However, it’s important to note that for 2023, RMDs must still be taken from these accounts, including those with a required beginning date of April 1, 2024. Also, while there is a minimum amount you must withdraw, you are always permitted to draw more than this minimum if you choose to.

Unlike Roth 401(k) accounts, Roth IRAs are not subject to Required Minimum Distributions (RMD) rules. If the Roth 401(k) account Required Minimum Distributions apply to you, rolling over assets from a Roth 401(k) to a Roth IRA can be a way to avoid taking RMDs.

If you roll over your Roth 401(k) money into a Roth IRA, you can effectively avoid taking RMDs during your lifetime. This strategy gives you more control over when and how much you withdraw from your retirement savings.   However, it’s important to note that the Roth IRA five-year rule applies, which means you may have to wait five years to pull your money out of the Roth IRA without penalty.

Roth 401(k) vs Roth IRA Summary Table

Roth 401(k) vs Roth IRA: Which Is Right For You?

A Roth 401(k) and a Roth IRA provide substantial tax benefits. If your employer provides a Roth 401(k) option and you’re also eligible to contribute to a Roth IRA, there are some factors you’ll want to consider.

A Roth 401(k) is an employer-sponsored retirement plan, and one of the main advantages of a Roth 401(k) is the higher contribution limit. In addition, many employers offer matching contributions, effectively giving you free money towards your retirement.

However, not all employers offer a Roth 401(k) option, and unlike a Roth IRA, a Roth 401(k) requires you to take required minimum distributions (RMDs) starting at age 73 (though for 2024 and later years, RMDs are no longer required).

A Roth IRA is an individual retirement account you open and fund yourself. Like a Roth 401(k), contributions are made with after-tax dollars, and contributions and earnings can be withdrawn tax-free in retirement.

Compared to Roth 401(k), a Roth IRA offers more flexibility regarding investment options and withdrawal rules.

For example, Roth IRAs allow you to withdraw your contributions at any time or at any age without incurring tax or penalty. Withdrawals on earnings, however, could be subject to income taxes and a 10% penalty, depending on your age and how long you’ve had the account. And unlike a Roth 401(k), there are no RMDs for a Roth IRA during your lifetime.

Roth IRAs, however, have an upper limit for how much you can earn in a year and still make eligible contributions. This is unlike Roth 401(k) plans, which don’t have these limits.

If your employer offers a match on your Roth 401(k) contributions, it makes sense to contribute at least enough to get the full match before contributing to a Roth IRA.

Contributing to both a Roth 401(k) and a Roth IRA can make sense when you’re able to contribute to both types of accounts and your goal is to maximize the amount of money put away each year towards retirement, as it allows you to take advantage of the unique benefits of each.

Overall, choosing between a Roth 401(k) and a Roth IRA will come down to your circumstances and retirement goals.

FAQs

Can I Have Both a Roth 401(k) and a Roth IRA?

You can maintain a Roth 401(k) in addition to a Roth IRA, but note that your employer must provide a Roth 401(k) option to be eligible. In addition, you can only make eligible contributions to a Roth IRA if you don’t exceed the stated income limits.

If you’re eligible to contribute to a Roth IRA, adding it to your retirement strategy alongside your Roth 401(k) plan could provide greater diversification. Here’s why:

• By contributing to a Roth IRA in addition to your 401(k), you can put away more for retirement.
• Your employer decides all the investment options for Roth 401(k) plans. Some plans may offer a self-directed option, also known as a brokerage window, which allows for a wider range of investments, such as individual stocks, bonds, and ETFs. However, not all plans offer this option.
• A Roth IRA is an individual retirement account that offers more investment choices, including individual stocks and ETFs.
• Unlike Roth IRAs, Roth 401(k) plans have no upper limit for how much you can earn in a year and still make eligible contributions.
• If you exceed the Roth IRA stated income limits, a traditional IRA is accessible to anyone with earned income (or any spouse whose partner has earned income).

Can I Keep My Roth IRA If I Change Jobs?

Yes, you can keep your Roth IRA if you change jobs. Unlike a Roth 401(k) plan tied to your workplace, IRA accounts are not linked to your employer and can be maintained even if you switch jobs.

Can I Keep My Roth 401(k) If I Change Jobs?

Yes, you can keep your Roth 401(k) account if you change jobs. Here are the typical options you have:

1. In most cases, you can simply leave your Roth 401(k) with your old employer. However, you’ll no longer have the option to contribute directly to the plan, and you’ll be limited to the investment options the plan provides.
2. You can roll over your Roth 401(k) balance into an individually held Roth IRA through a tax-free transfer. This option will give you the most flexibility and investment choices. It’s also convenient because you won’t have to worry about moving your account again if you change employers in the future.
3. If your new employer offers a Roth 401(k) plan that allows transfers, you can transfer your Roth 401(k) plan balance to the new plan. Once a transfer is complete, your entire balance is held within the new plan.

How Do I Open a Roth IRA Account?

Here are the general steps to open a Roth IRA account:

1. You can open a Roth IRA account at a bank, credit union, or brokerage. When choosing an institution, look for one that offers a wide range of investment options, has low fees, and has a user-friendly online interface.
2. To be eligible to contribute to a Roth IRA account, you’ll need to meet certain income requirements as we covered above

After you’ve opened your Roth IRA account, you can fund it by transferring money from your bank account or by rolling over money from an existing retirement account.