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Roth 401(k) vs. Roth IRA: Differences + which is better for you

Roth 401(k) and IRA are similar thanks to after-tax contributions and tax-free withdrawals during retirement. But they do have important differences you need to know.

By:

Theo Katsoulis, CFA

•

Reviewer:

Tanza Loudenback, CFP®

April 19, 2024

•

6 minutes

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Key takeaways:

Roth 401(k)s and Roth IRAs let you put after-tax contributions toward your retirement savings and withdraw those funds tax-free upon retirement.
A Roth 401(k) has higher contribution limits than a Roth IRA, no income limits, and offers employer matching.
The Roth 401k is employer-sponsored while the Roth IRA is an independent account you would open directly through a brokerage.
Deciding between the two options will depend on your company’s retirement plan, your current income level, and your preferred risk tolerance.

When looking through your employer-sponsored retirement plans, you may have wondered how a Roth 401(k) differs from a traditional 401(k). And is it similar to a Roth IRA? Both Roth 401(k)s and Roth IRAs allow you to contribute after-tax dollars, setting the stage for tax-free income in retirement. Traditional retirement accounts accept pre-tax contributions, and withdrawals are taxed.

Read on for a thorough breakdown of the similarities and differences between a Roth 401(k) and a Roth IRA. We’ll also share some tips for figuring out if one (or both) is a viable option to help you strengthen your retirement portfolio.

How Roth 401(k) works

A Roth 401(k) lets you contribute to your employer-sponsored retirement plan with money from your paycheck after taxes have been taken out.

The real magic happens down the road, when you retire withdrawals from a Roth 401(k) will be tax-free. This is the opposite of a traditional 401(k), which does not tax contributions when you add them to your account—therefore lowering your current taxable income—but does tax money you withdraw. A Roth 401(k) is a compelling option if you anticipate being in a higher tax bracket at retirement age.

How Roth IRA works

With a Roth IRA, you contribute money after taxes, similar to a Roth 401(k). But a Roth IRA typically offers a wider selection of investment options than the limited options identified by the Roth 401(k) plan’s administrator. Roth IRA investment options may include individual stocks, bonds, cash alternatives, and more.

Both Roth accounts create tax advantages when you retire since future withdrawals will be completely tax-free. This can particularly benefit those planning for estate purposes or who wish to maximize their retirement savings' growth potential.

Tip: A Roth IRA is best used in addition to other retirement accounts. For example, if your employer offers 401(k) matching contributions, you’ll leave free money on the table if you only contribute to a Roth IRA. And with lower contribution limits than a 401(k), a Roth IRA alone may not allow you to meet your savings goals.

Roth 401(k) vs. Roth IRA comparison chart

Although they sound similar and share a few characteristics, there are a lot of nuanced differences between a Roth 401(k) and a Roth IRA, as the chart below reveals.

A chart comparing the rules for Roth 401(k)s and Roth IRAs on the road to retirement

Contribution limits

Roth 401(k)	Roth IRA
• Annual limit for contributions is $23,000 as of 2024.	• Annual limit for contributions is $7,000 as of 2024.
• You can add an extra $7,500 as a catch-up contribution if you're 50 or older.	• You can add an extra $1,000 as a catch-up contribution if you're 50 or older.
	• Contribution limits are set by the IRS and are adjusted for inflation annually, though, so it’s important to monitor the current amount allowed.

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Early withdrawal

Roth 401(k)	Roth IRA
• Your Roth 401(k) contributions (not the earnings) can usually be withdrawn tax-free at any time, with no penalty attached if it’s been five years since the first contribution.	• You can usually withdraw contributions both tax- and penalty-free.
• If you take the earnings out too early (before age 59 ½) the IRS will charge the 10% penalty and income taxes on them.	• If you start dipping into the earnings before you turn 59½, a 10% penalty and income taxes will come into play.
• There are exceptions for disability or death.	• You may be able to avoid the penalty on early withdrawals when related to disability, death, or a first-time home purchase.

Withdrawal during retirement

Roth 401(k)	Roth IRA
• Contributions and earnings are yours to enjoy tax-free upon your retirement.	• Contributions and earnings are tax-free upon your retirement, as long as your Roth IRA has been established for at least five years and you've reached 59½.
• Effective in 2024, there are no required minimum distributions (RMDs) for a Roth 401(k).	• There are no required minimum distributions (RMDs) for a Roth IRA.
• Prior to 2024, the IRS had required minimum distribution rules for Roth 401(k)s.

Plan loans

Roth 401(k)	Roth IRA
• With a Roth 401(k), you may have the option to take out a loan from your account to buy a house or handle a financial emergency.	• You can't borrow against your Roth IRA.
• This loan is essentially borrowing from your own contributions, and you can take out up to 50% of your balance up to $50,000.	• A Roth IRA doesn't permit direct loans.
• You have to repay the loan with interest that goes right back into your retirement savings, but it's a unique feature that allows you to access your funds in a pinch.
• If you don’t pay yourself back within a certain amount of time, your loan will count as a withdrawal, and you’ll owe income taxes and penalties.

Income limits

Roth 401(k)	Roth IRA
• The Roth 401(k) welcomes anyone to participate through their employer-sponsored plan, with no limitations based on income.	• The Roth IRA requires that single individuals must earn no more than $161,000, while couples filing jointly cannot exceed a modified adjusted gross income (AGI) of $240,000.
	• You may be able to skirt the income limits on Roth IRAs through the mega backdoor Roth limit.

Employer matching

Roth 401(k)	Roth IRA
• Many employers offer to match employees’ Roth 401(k) contributions, which helps amplify their retirement savings.	• Since Roth IRAs are typically self-funded, there's no employer match to sweeten the deal.
• Employers usually set guidelines, like matching a percentage of your contributions up to a certain dollar limit.
• You shouldn’t pass up the ability to earn “free” money through an employer match, so a Roth 401(k) could be more advantageous than a Roth IRA in this aspect.

Required distributions

Roth 401(k)	Roth IRA
• As of 2024, Roth 401(k)s do not impose mandatory distribution mandates during the individual account holder’s lifetime.	• Roth IRAs do not impose mandatory distributions during the individual account holder’s lifetime.
• Up through 2023, there had been a mandatory distribution rule for Roth 401(k)s that would kick in when you reached the age of 72 or when you decided to exit the workforce, whichever came first.
• As of 2024, that mandate no longer exists.

Investment options and control

Roth 401(k)	Roth IRA
• While you have some freedom to select from the provided options in a Roth 401(k), your employer's plan provider determines your investment choices.	• A Roth IRA lets you handpick your investments from more possibilities, including individual stocks, bonds, and mutual funds.
	• You become the sole decision-maker, enabling you to build a customized investment portfolio to suit your goals.

Tax considerations

Roth 401(k)	Roth IRA
• Roth 401(k) contributions are made with after-tax income.	• Roth IRA contributions are made with after-tax income.
• Since you've already paid income tax on the money before it hits your retirement account, the real tax advantage reveals itself when you retire and all of your withdrawals are tax-free—even those including your earnings.	• You will enjoy tax-free withdrawals of both your contributions and earnings after age 59 ½.

Roth 401(k) or Roth IRA? How to choose

If you’re on the fence about which one will work best for you, there are several key factors to consider when making your decision.

Flow chart guiding you through choice between investing in a Roth 401(k) vs a Roth IRA

Maximizing tax advantages:

‍You can reduce your taxable income during your retirement by maxing out your retirement contributions now. By contributing the maximum amount to your Roth 401(k) and taking advantage of any offered employer match up to the limit, you’ll increase the tax-free money you have available for retirement. With a Roth IRA, your money can grow tax-free indefinitely. It can be especially helpful if you’re in a lower tax bracket now than you expect to be upon retirement. If that’s the case, you’ll pay significantly less taxes on the money now than when you pull it out later as a tax-free withdrawal.

Employer offerings:

‍Your choice may depend on your workplace's retirement plan offerings. If a Roth 401(k) isn't on the menu, consider a Roth IRA to give you more control over your financial portfolio.But, if your company has a 401(k) matching program, also take advantage of it through a traditional or Roth 401(k). If you don’t, you’ll be leaving free money for your retirement on the table.

Long-term tax strategies:

‍If you want a mix of tax options in your long-term plan, contributing to both a Roth 401(k) and a Roth IRA can be a balanced approach. When projecting your future income while retirement planning, remember that both types of Roth accounts will offer tax-free withdrawals upon retirement.

Fees:

‍Take the time to check the investments your Roth 401(k) plan offers to see if they’re low-cost. Generally, you want a mutual fund with an expense ratio, which represents the percentage of assets deducted for management and operational costs, of 0.5% or less. Paying more than 1% is considered too much. So, if your Roth 401(k) costs are over the 1% mark, you may want to shift toward the Roth IRA instead.

The Playbook take

Now that you’ve explored the Roth side of the financial family tree, consider the tax advantages a Roth 401(k) and a Roth IRA can provide. You can make an informed decision about their potential impact on your retirement planning by building a personalized financial plan.

Can I convert a Roth 401(k) to a Roth IRA?

When you convert a Roth 401(k) to a Roth IRA, you may gain more control over your investments. But consider the tax implications since the five year clock for withdrawing earnings from a Roth IRA resets when you roll over the money. If you want to make the switch, it's a good idea to consult with a financial advisor first.

Can I contribute to both a Roth 401(k) and a Roth IRA?

Yes, you can contribute to both a Roth 401(k) and a Roth IRA in the same tax year. It's a smart move for diversifying your retirement savings and enjoying the unique benefits each account offers.

Which is better, Roth 401(k) or Roth IRA?

Your personal financial goals and circumstances will help you determine if a Roth 401(k) or a Roth IRA is a good fit for you. A Roth 401(k) is great if your employer offers it, as it allows higher contribution limits and potential employer matches. On the other hand, a Roth IRA offers more flexibility in investment choices, making it a solid option for individual control.

About the author

Theo Katsoulis, CFA

Head of Investments

Theo brings an extensive background in Institutional Asset Management. With a B.A. from Villanova University's School of Business, and having passed the rigorous Series 65 and CFA examinations, he brings significant expertise from portfolio management to understanding intricate financial infrastructures. As Head of Investments at Playbook, he ensures consumers receive exceptional diligence and care for their investment portfolios.

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Tanza Loudenback, CFP®

Editor

Tanza is a CFP® certificant, writer, and editor. From 2015 to 2021, she was a top-read author and editor at Insider. Her work focuses on helping people make smart decisions with their money and is published by a variety of online publications.

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