Roth 401(k)s and Roth IRAs share the ultimate goal of tax-free distributions of earnings. But while both of these accounts are funded with amounts that have already been taxed, the path to that tax-free goal is paved with different rules for each of these two types of accounts.
As you consider your retirement planning needs, which will likely include adding Roth options for a tax-diversified retirement nest egg, the following overview of the differences might be helpful with determining which Roth account is more suitable.
Related: IRAs for Beginners
Note: A designated Roth contribution can be made to a designated Roth account under a 401(k), 403b, thrift savings plan (TSP), or for a 457(b) plan; contributions are usually labeled by the type of plan to which they are made. For instance, if a designated Roth contribution is made to a 401(k) plan, the account to which the contribution is made is called a Roth 401(k) account. For purposes of this article, Roth 401(k)s, Roth 403(b)s, Roth TSPs, and Roth 457(b) accounts will be referred to collectively as Roth 401(k)s, unless otherwise stated.
1. Contribution Limit
The contribution limit for a Roth 401(k) is higher than the contribution limit for a Roth IRA.
For the calendar year 2023, a participant may make contributions of 100% of compensation up to $22,500 to a Roth 401(k). A participant who is at least age 50 by the end of the year may make an additional catch-up contribution of $7,500.
These contributions apply on a per individual basis, and are aggregated with contributions to traditional 401(k) plans. As a result, the limit of $22,500 plus $7,500 catch-up can be:
- Contributed to one Roth 401(k), or
- Split among more than one Roth 401(k) and traditional 401(k)s, Roth and traditional 403(b)s, and Roth and traditional thrift savings plans.
Contributions to 457(b) plans are not included in this aggregation.
The contribution limit for a Roth IRA is 100% compensation up to $6,500 in 2023, with a catch-up contribution of $1,000 for those who are at least age 50 by the end of the year.
Roth IRA contributions are aggregated with contributions to traditional IRAs. This means that an individual;s total regular contribution to both a traditional and Roth IRA must not exceed $6,500 for the year, or $7,500 for the year if they are at least age 50 by the end of 2023.
Contributing to Both
Contributions to a Roth 401(k) and Roth IRA do not affect each other. Therefore, an individual can make the maximum contribution amount to both accounts if eligible.
2. Income Limits
Roth 401(k) contributions are not subject to any income limits.
On the other hand, an individual is eligible to make a contribution to a Roth IRA only if that individual’s modified adjusted gross income (MAGI) is below certain amounts. This MAGI is based on the individual’s tax filing status. The following table shows the MAGI limits.
|Tax Filing Status||MAGI||Allowed Contribution|
|Single||$129,000 or less||100%|
|$144,000 or more||None|
|Married Filing Jointly||$204,000 or less||100%|
|$214,000 or more||None|
|Married Filing Separately||Less than $10,000||Partial|
|$10,000 or more||None|
For individuals whose MAGI falls within the phase-out range, calculations must be done to determine the amount of contribution for which they are eligible.
An individual can not establish a Roth 401(k) plan independently, therefore access to a Roth 401(k) is dependent upon availability through an employer. Employers that want to offer Roth 401(k) accounts must first establish a traditional 401(k) plan and then add the Roth 401(k) feature.
Anyone can establish a Roth IRA, and regular Roth IRA contributions can be made to the account as long as the individual’s MAGI does not exceed the limits above.
4. Required Minimum Distributions
Roth 401(k) accounts are subject to the same required minimum distribution (RMD) rules that apply to traditional 401(k) accounts. Therefore, the account owner must start taking RMDs from their Roth 401(k) for the year in which they reach age 72, and continue for every year thereafter. Roth 401(k) beneficiaries are also subject to RMD rules.
Roth IRA owners are not subject to RMD rules. The same goes for Roth IRA beneficiaries, with an exception that applies to spouse beneficiaries who transfer the inherited assets to their own Roth IRAs.
5. Qualified Distribution Definition and the 5-Year Rule
Qualified distributions from a Roth 401(k) or a Roth IRA are tax-free and penalty-free. Non-qualified distributions may be subject to income taxes, and a 10% early distribution penalty on any taxable amount.
The 10% early distribution penalty does not apply if the distribution occurs on or after the date on which the account owner reaches age 59½, or if an exception to the penalty applies.
Qualified Distribution Definition
A distribution from a Roth 401(k) is qualified if it meets the following two requirements:
- The individual has had the Roth 401(k) for at least five years, and
- Is either; age 59½ at the time the distribution is made, disabled, or deceased (in which case the distribution would be taken by a beneficiary).
Roth IRA distributions must also meet these requirements in order to be qualified, but there are two different distinctions:
- The five-year rule for a Roth IRA is determined on an aggregate basis, whereas the five-year period for Roth 401(k)s is determined on a per employer plan basis (see below).
- For the second option, a distribution from a Roth IRA is also considered qualified if the five-year period has been met and the distribution is taken for first-time home buyer purposes. This is subject to a lifetime limit of $10,000.
6. Defining the 5-Year Period For a Qualified Distribution
When determining whether or not the five-year period has been met, each of an individual’s Roth 401(k) accounts must independently meet this requirement. An exception applies when two Roth 401(k) accounts under different employer plans are combined. Under this exception, if one Roth 401(k) is moved to another using the direct rollover method, then the five-year period starts with the Roth 401(k) that was first established and funded. On the other hand, if the movement is done using the indirect rollover method, the five-year period starts when the receiving Roth 401(k) was established and funded.
For Roth IRAs, this five-year period starts with the individual’s first Roth IRA. This is because all of an individual’s Roth IRAs are aggregated for this purpose.
7. Recharacterization Option
Recharacterization occurs when a contribution is changed from a traditional to a Roth or vice versa. A recharacterization must be done by the individual’s tax filing due date plus extension, and must include any net income attributable to the transaction being recharacterized.
Once an individual makes an election to treat an elective contribution as a Roth 401(k) contribution, that election is irrevocable. As such, contributions to a Roth 401(k) may not be recharacterized.
A contribution to a Roth IRA can be recharacterized to a traditional IRA contribution, and vice versa.
Awareness of the Difference Can Help Decision-Making
While you can potentially make contributions to both of these types of accounts in some cases, an awareness of these differences – and of course any similarities – can help to ensure that you choose the account with the features that are more suitable for you. Awareness can also help to prevent you from choosing an account for which you might be ineligible.
Of course, consideration should also be given to whether a traditional account might be more suitable for you than a Roth account. In order to make this determination, a Roth versus traditional analysis should be done by a financial professional.
Denise Appleby is CEO of Appleby Retirement Consulting, Inc.