September 17, 2017

Roth 401(k) vs Roth IRA: What’s the difference and which one should you have?

Bottom line: Have both for maximum retirement savings of $23,500, or choose the Roth 401(k) if you have to select one.

You’re planning for retirement. That’s good. In fact, you are among only a third of Americans who are, which is decidedly too low. So pat yourself on the back for doing this research.

We’re going to cover the differences between a Roth 401(k) and a Roth IRA and which you should have. Spoiler alert: it’s both (and choose the Roth 401(k) over the Roth IRA if you to select one).

Let’s dive in and look at why.

What’s the difference

A Roth 401(k) is nearly identical to the Traditional 401(k) in every way except with the Roth, your contribution goes into your account once it’s taxed (whereas with the Traditional, you’re taxed when you withdraw at an older age).

Traditional 401(k)

To make sure we have our bases covered, let’s quickly cover what a 401(k) is. You may in fact already have one.

These are powerful retirement accounts allowed by the IRS, and provided through your employee, which allow you to deduct pre-tax contributions to the account for retirement of up to $18,000 ($24,000 if you’re 50 or older).

The benefits are so great of a 401(k) there are not many excuses to not own one: you can stash away more money than most other retirement account options, you reduce your income limit, your employer may provide matching (read: free money), and theres is no income limit.

Roth 401(k)

So what’s the Roth 401(k) then?

If you have read our overview of what a Roth IRA is, you’ll find there is a key question distinguishing Roth and non-Roth accounts: are you stashing away pre-tax money or post-tax money? Anytime you see “Roth,” think post-tax money.

A Roth 401(k) is synonymous with the Traditional 401(k) but you are contributing post-tax money into the account. The contributions and rules are the same.

How do you decide which is the better? You need to decide whether it’s best to be taxed now or later. Similar to the Roth IRA vs Traditional IRA debate, the IRS will tax you sooner or later. It’s best to optimize for when that event occurs.

Do you expect to make more money now or in the future? If you are younger, typically the answer is you expect to make more money in the future. And because of this, the Roth 401(k) is the better option. If you are older or planning to retire soon, the regular 401(k) may be the better option.

Similar to the Traditional 401(k), and one important note, is the forced withdrawal at age 70.5. This isn’t a concern for most yet some may not find this ideal if withdrawals are not needed at that age.

If you have a Roth 401(k) account, employers can match your contributions. However, do note employers contribute their match to a Traditional 401(k) account.

Roth IRA

The Roth IRA is a retirement account allowing you to contribute $5,500 per tax year (or $6,500 if you are 50 or older) to your retirement. Think of the Roth IRA as a completely separate account from the 401(k). Yes, it’s also a retirement account, but it has its own rules which govern contributions, eligibility, and withdrawals. The beauty, however, is you can have both.

A Roth IRA is opened by an individual and is not provided by your employer. This can be convenient since many companies don’t provide their own 401(k) or Roth 401(k) accounts.

There are rules however which limit your ability to have a Roth IRA account.

Income limit

Unlike the Roth 401(k), high income earners may not be eligible to open an account. If you are single and making $133,000 per tax year or more (or $196,000 if you are filing with your spouse), you are ineligible to contribute. (However you can use the Backdoor Roth Method we outline.)

Contribution limit

Where the Roth 401(k) allows up to $18,000 per year ($24,000 if you’re 50 or older), the Roth IRA allows $5,500 ($6,500 if you’re 50 or older). This is a $12,500 difference per year, which, trust us on this one, adds up to a huge difference come retirement.

These limitations are often why, when answer the question of whether you want a 401(k) vs IRA option, you nearly always want to open and max out the 401(k) first, then open an IRA account.

One benefit over the 401(k) alternative is there is no required withdrawal at 70.5, making the Roth IRA particular attractive for leaving it to a spouse or descendants.

At a glance

Here’s a table for looking at differences between the two account types. The Traditional 401(k) is added for good measure:

Account type Income limit Contribution limit per year Withdrawal age Pre-tax income? Post-tax income?
Roth 401(k) No limit $18,000 ($23,500 if 50 years or older Withdrawals required at 70.5 years old or suffer penalty No Yes
Traditional 401(k) No limit $18,000 ($23,500 if 50 years or older Withdrawals required at 70 years old or suffer penalty Yes No
Roth IRA $133,000 filing single, $196,000 filing with spouse $5,500 ($6,500 if 50 years or older) No required withdrawal No Yes

You can see the only difference between the Roth 401(k) and the Traditional 401(k) is the pre-tax vs post-tax income columns. The Roth IRA however has notable differences in income and contribution limits. Its perk of not requiring withdrawals at retirement age is beneficial for some.

Can you have both a Roth 401(k) and Roth IRA?

Yes, and we encourage you to do so. Having both allows to contribute $23,500 per year ($30,500 if you’re 50 or older)! If you were contributing to both, you would be socking away this much money post-tax (remember Roth means retirement money after you’ve already been taxed by Uncle Sam) to grow into a retirement account. Your withdrawals are tax free.

Which should you have?

We arrive at the crux of our question. Which should you have? The answer is both. But to be more clear, the breakdown depending on most people’s financial situations is the following:

  • Having both a Roth 401(k) and a Roth IRA is the best: Doing so would allow yearly contributions to retirement accounts to be $23,500 or $30,500 if you’re 50 or older.
  • Roth 401(k) is better if you have to choose one: Between a Roth 401(k) or Roth IRA, the Roth 401(k) is usually the better option, allowing a contribution of $18,000 vs $5,500 and much less eligibility requirements.
  • Roth IRA is a great option if you don’t have a Roth 401(k) or Traditional 401(k) through your employer: If a Roth 401(k) or Traditional 401(k) is not an option, the Roth IRA is a great way to save for retirement.

That’s all there is to it!