- With its high contribution limits and no income limits, putting money into a Roth 401(k) could be a smart idea.
- Roth IRAs also have lots of benefits, including tax-free withdrawals in retirement.
- Spoiler alert: You might be able to contribute to both!
Looking to set aside big money for retirement? (Who isn’t? Am I right?) Both a Roth 401(k) and a Roth IRA could help you get closer to your retirement savings goals.
While these two accounts share similar names, there are some crucial differences to be aware of. Here’s what you need to know about each, how they work, their pros and cons and what all the rules and limitations are.
Inside this article
What’s a Roth 401(k) and how does it work?
As its name suggests, a Roth 401(k) is a unique type of retirement savings account that blends a Roth IRA and a 401(k). Like a Roth IRA, it offers the perk of post-tax employee contributions, meaning you won’t be taxed on money you contribute or on any gains, provided you withdraw funds after age 59 ½ and you’ve contributed to your account for five years.
Unlike a Roth IRA, a Roth 401(k) is employer-sponsored and has no income limitations. Roth IRA contributions phase out once you earn a certain amount. With a Roth 401(k), it doesn’t matter how much you make—you’ll still be able to contribute.
Annual employee contribution limits for a Roth 401(k) in 2022 are $20,500 if you’re under age 50 or $27,000 if you’re 50 and over.
What’s a Roth IRA and how does it work?
A Roth IRA also offers some tax advantages and other perks. As with the Roth 401(k), contributions are made post-tax, making a Roth IRA a good choice if you expect to be in a higher tax bracket when you retire.
“Contributions to a Roth IRA are made with after-tax dollars. Once the money is a Roth IRA, you are never taxed on it again,” says Danene Cronin, a financial advisor and vice president of wealth management at The Armstrong Group at Morgan Stanley. “That means those dollars grow tax free, and when they are withdrawn, there are no taxes owed.”
Plus, you won’t be required to make withdrawals when you reach age 72; with a Roth 401(k), you’re subject to required minimum distributions (RMDs). We’ll discuss why no RMDs are beneficial shortly.
Despite the benefits, there are income and contribution limits to be aware of with a Roth IRA. If your modified adjusted gross income exceeds $144,000 as an individual or $214,000 as a household in 2022, you can’t contribute to a Roth IRA at all. And annual contribution limits are relatively low—just $6,000 if you’re under 50, or $7,000 if you’re 50 and over.
Roth 401(k) pros and cons
No income limits: If the income limits of a Roth IRA concern you, a Roth 401(k) could be a good option. You won’t need to worry about earning too much to contribute to this type of account because there are no income limits.
High contribution limits: Interested in and able to contribute $20,500 to retirement each year? With a Roth 401(k), you can do that!
Employer matching possible: In addition to high contribution limits, you’ll also benefit from employer matching with a Roth 401(k)—assuming your company offers this perk. Employers can match up to the lesser of $61,000 annually or 100% of your total yearly compensation. Of course, these are REALLY high matching limits, and you’ll be more likely to see a 3% or 6% employer match.
Required minimum distributions: When you reach a certain point, you’ll be required to withdraw money from your Roth 401(k). This account is subject to required minimum distributions (RMDs), similar to a traditional 401(k) account. RMDs typically begin at age 72, though you might not be required to take them if you’re still working.
Limited investment choices: Since a Roth 401(k) is employer-sponsored, your investments are limited to those your employer has selected for the plan. This could be a drawback if you’re interested in diversifying beyond the investments offered by your company.
Roth IRA pros and cons
No required minimum distributions: Unlike a traditional IRA or traditional or Roth 401(k), you’re not required to withdraw money from your Roth IRA account once you reach age 72. In fact, you can continue to contribute and leave the money alone entirely if you choose—and your investments can continue to grow. This flexibility can be useful if you decide you don’t need to access the account until later. “That money can continue to grow tax free and can even be passed down to heirs,” says Cronin.
Many investment choices: Since Roth IRAs are not employer-sponsored, you’ll have a broader array of investment choices than you would with a Roth 401(k). For those who want to build a diversified portfolio, more choices can be a valuable perk.
Low contribution limits: You know that $20K+ contribution limit you get with a Roth 401(k)? You won’t get that with a Roth IRA. Max contribution limits for 2022 are $6,000 for individuals under 50 and $7,000 for those 50 and over.
Has income limits: In addition to contribution limits, Roth IRAs also have income limits. Contributions begin to phase out once your MAGI exceeds $129,000 as an individual or $204,000 as a household. And when your MAGI is higher than $144,000 as an individual or $214,000 as a household, you can’t contribute at all.
No employer matching: Since a Roth IRA is not an employer-sponsored account, you won’t get the benefit of a company match. Instead, it’ll be all on you to save for retirement.
Let’s compare the two!
|Roth 401(k)||Roth IRA|
|Tax treatment||Employee contributions are post-tax, employer contributions are pre-tax||Contributions are post-tax|
|2022 contribution limits||$20,500 for those under 50, $27,000 for those 50 and over||$6,000 for those under 50, $7,000 for those 50 and over|
|Employer matching available||Yes||No|
Wait, can I have both at once?
We’ve got some good news for you: As long as your employer offers a Roth 401(k) option and your income falls below the limitations for a Roth IRA, you can probably have both. This way, you’ll get the high contribution limits associated with the Roth 401(k)—plus all the other benefits—and the flexibility of the Roth IRA. It’s a win-win!