Roth 401(k) vs. Roth IRA: What’s the Difference?

Roth 401(k) vs. Roth IRA: An Overview

There is no one-size-fits-all answer as to which is better, a Roth 401(k) or a Roth individual retirement account (IRA). It all depends on your unique financial profile: how old you are, how much money you make, and when you want to start withdrawing your nest egg.

With advantages and disadvantages to both, here are the key differences you should consider when comparing the two types of Roth accounts.

Roth 401(k)

Created by the Economic Growth and Tax Relief Reconciliation Act of 2001, Roth 401(k)s are a hybrid, blending many of the best parts of traditional 401(k)s and Roth IRAs to give employees a unique option when it comes to planning for retirement.

Like traditional 401(k)s, contributions are made directly from an employee’s paychecks and the employer may match part of those contributions. Unlike traditional 401(k) plans, income taxes are paid on that money before it is deposited into the account, so withdrawals will not be subject to income tax at withdrawal.

Roth IRA

Roth IRAs were established by the Taxpayer Relief Act of 1997 and named for U.S. Sen. William Roth of Delaware. What sets them apart from traditional IRAs is that they are funded with after-tax dollars, making qualified distributions tax-free.

Also, unlike 401(k) plans, a Roth IRA is not sponsored by your employer. This means that you can continue investing in the same Roth IRA, even after you change jobs. Individuals can select the financial institution to hold custody of their IRA, the investments they want to contribute money towards, and decide how much to contribute to the account each year.

Key Differences

Both the Roth 401(k) plans and the Roth IRA plans use after-tax dollars, meaning that the owner does not have to pay income taxes when they receive distributions, making this advantageous to those who expect to earn more money later in life. However, there are several key distinctions between a Roth IRA and a Roth 401(k) plan, which are discussed below.

Income Limits

Roth IRAs come with an income limit. Per the Internal Revenue Service (IRS), individual taxpayers with an adjusted gross income (AGI) of over $153,000 in 2023 or married couples filing jointly who made over $228,000 in 2023 are not eligible for Roth IRA contributions.

These eligibility thresholds are higher in 2024, with eligibility phasing out for individuals making more than $161,000 and couples making more than $240,000.

A big advantage of a Roth 401(k) is the absence of an income limit, meaning that even people with high incomes can still contribute. This pairs well with the Roth 401(k)’s higher contribution limits.

Required Minimum Distributions (RMDs)

With a Roth 401(k), you no longer have to take required minimum distributions (RMDs) after 2023. So for 2024 and beyond, RMDs in designated Roth accounts in a 401(k) are no longer required; however, for 2023, you must still take RMDs. As of Jan. 1, 2023, the passage of the SECURE 2.0 Act increased the age to begin RMDs from 72 to age 73 for individuals born between 1951 and 1959 and age 75 for those born in 1960 or later.

Failure to meet your RMD during the year may subject you to a financial penalty of 25% of the shortfall. However, if the mistake is corrected promptly, the penalty is reduced to 10%.

The only circumstance to defer taking RMDs is if you are still employed and are not a 5% owner of the company sponsoring the plan. Again, this is only applicable through 2023, where RMDs are due by April 1, 2024.

A Roth IRA does not require you to take RMDs—ever. The flexibility gives you the option to keep contributing to your account and letting those funds grow indefinitely. You can also pass your Roth IRA to your spouse or descendants.

For taxable years beginning after Dec. 31, 2023, the SECURE 2.0 Act also eliminates the pre-death RMD for the owner of a Roth-designated account in an employer 401(k) or other retirement plans.

Under current law, required minimum distributions are not required to begin before the death of the owner of a Roth IRA, although pre-death distributions are required in the case of the owner of a Roth-designated account in an employer retirement plan.

Investment Options

With a Roth 401(k), your investment options are limited to those offered by the plan administrator, commonly various types of mutual funds with set expense ratios.

A Roth IRA has a much wider range of investment options. Also, you can shop around to see which custodians and vehicles carry the smallest transaction and administrative expenses.

Contributions and Contribution Limits

The biggest advantage to Roth 401(k)s is the possibility of matching contributions from an employer. Employers are offered a tax incentive to make them. Participants in the plans can contribute an annual maximum of $22,500 for 2023 and $23,000 for 2024.

Individuals can contribute an additional $7,500 catch-up contribution in 2023 and $7,500 in 2024 if they turn 50 years old by the end of the year. Beginning in 2024, IRA catch-up contributions will be adjusted for inflation and subject to cost of living adjustments or COLAs.

There is a hitch, though. Employers may match your contribution with pretax dollars, and when the Roth is funded with post-tax dollars, the matching funds and their earnings will be placed in a regular 401(k) account. That means you may pay taxes on this money—and on its earnings—once you start taking distributions.

Roth IRAs have a much lower contribution limit—$6,500 per year for 2023 and $7,000 for 2024, compared to a Roth 401(k). In addition, Roth IRAs are self-funded and do not allow for matching employer contributions.

Beginning in 2025, employers will be required to automatically enroll eligible employees in new 401(k) plans with a participation amount of at least 3% but no more than 10%. The contribution escalates at the rate of 1% per year up to a minimum of 10% and a maximum of 15%.

Withdrawals

Access to the funds in your Roth 401(k) before age 59½ is limited. Tapping nest eggs before retirement should always be a matter of last resort, but if you must do it, you can’t take cash out of your Roth 401(k) without incurring a 10% penalty.

With a Roth IRA, you can withdraw an amount equivalent to the contributions you have made at any time without penalties or taxes. This does not, however, apply to a Roth IRA’s earnings, for which preretirement withdrawals if you’re under age 59½ still come with a 10% penalty.

However, under certain circumstances, such as buying a home for the first time or incurring childbirth costs, you are allowed withdrawals of earnings from your Roth IRA free of penalty if you’ve held the account for less than five years, and free of penalty and taxes if you have held it for more than five years.

With the passage of the SECURE 2.0 Act, participants will be able to access up to $1,000 annually from retirement savings for emergency personal or family expenses without paying the 10% early withdrawal penalties beginning in 2024.

Additionally, employees will be able to set up a Roth emergency savings account with up to $2,500 per participant. Survivors of domestic abuse can withdraw the lesser of $10,000 or 50% of their retirement account without penalty and victims of a federally declared disaster can withdraw up to $22,000 from their retirement account without penalty.

Loans

An advantage of a Roth 401(k) account is the ability to borrow money against your account balance. You can borrow up to 50% of your account balance or $50,000, whichever is smaller.

However, if you fail to pay back the loan as per the terms of the agreement, that money could be considered a taxable distribution.

Unlike Roth 401(k)s, Roth IRAs don’t allow loans but do permit a Roth IRA rollover. During this period, you have 60 days to move your money from one account to another. As long as you return that money to it or another Roth IRA in that time frame, you are effectively getting a 0% interest loan for 60 days.

The Bottom Line

When comparing a Roth IRA with a Roth 401(k), each has its own set of perks and benefits. Neither is inherently better than the other. For many, it may help you at some point to switch between them to capitalize on the benefits of both.