The Differences Between a Roth IRA and Roth 401(k)

Saving for retirement is a big deal, with many people listing retirement as their top financial priority. Unfortunately, it can be downright confusing at times. With so many letters, numbers, and acronyms floating around, it’s easy to get overwhelmed. That’s why we have put together some information to help you better understand key differences between Roth IRAs and Roth 401(k)s, and determine which options best align with your goals.

First, it’s important to remember the key similarities between Roth IRAs and Roth 401(k)s. With both account types, all contributions are post-tax. This means you pay taxes on the income you contribute now, making it tax-free when you draw on it during retirement.

Employer Match

The biggest, and often most attractive, difference between a Roth IRA and a Roth 401(k) is the potential for an employer match. Many 401(k) plans offer employer matching contributions up to a certain amount. This is often equated to free money, and while it’s always a good idea to be skeptical when the term “free money” is thrown around, in this instance it largely rings true. If your employer offers a match, it’s virtually always the smartest decision to max out 401(k) contributions up to the amount being matched before considering funding another account. It’s important to note that while the contributions you make to a Roth 401(k) will be post-tax, any matching contributions will be made pre-tax, meaning they will be placed in a separate traditional 401(k) and subject to taxation as ordinary income during retirement.

Contribution Limits

Another big difference is the limit on the annual amount you can contribute. The contribution limit for a Roth 401(k) in 2019 is $19,000 (or $25,000 if over the age of 50), whereas the contribution limit for a Roth IRA in 2019 is $6,000 (or $7,000 if over the age of 50). This means a Roth 401(k) plan allows you to put away more for retirement on an annual basis. Additionally, some high-income earners may not qualify for a Roth IRA at all. In order to qualify for Roth IRA contributions, your adjusted gross income cannot exceed certain thresholds. For a married taxpayer filing jointly, that threshold is $203,000. For a single taxpayer it’s $137,000. If your income exceeds these ranges, a Roth IRA is not going to be an option that is available.

Investment Options and Limitations

A major drawback to Roth 401(k) plans is the potential for a limited availability of investment options. Depending on your employer’s plan, there may not be a wide range of funds to choose from and they may carry high expense ratios. Take a close look at what your plan offers and decide if it’s a limiting factor for you. If so, you may choose only to contribute as much as your employer matches and then begin funding a Roth IRA. Contrary to Roth 401(k)s, Roth IRAs do not come with parameters on the kind of investments you can choose from, allowing you to have more control over your portfolio, the investments you make, and the fee structure that fits you best.

In summary, some people can max out contributions to their Roth 401(k) and still have room in their budget to contribute to a Roth IRA. Others have too much income to qualify for a Roth IRA and therefore don’t have to worry about deciding between the two. Yet for some individuals, this may be a conversation to have on an annual basis, reexamining which course of action best aligns with their current goals. Wherever you find yourself on your retirement savings journey, it is never too late to examine your options. Contact the Marietta Wealth financial team today to help you build a savings plan.