Roth IRA’s & Roth 401k’s: Untangling the Differences

Roth IRA’s and Roth 401k’s are two similar plans that help you save for your retirement, but the Roth 401k has a few key differences from the Roth IRA. So, which is better?  Read on and you decide…

Function

Since your Roth IRA is a personal account, rather than an employer account like a 401k (whether Roth or traditional), you need to contribute to Roth IRA on your own.  If your employer does not offer a Roth 401K, unfortunately, you can’t sign up to contribute.

Contribution Limits

One of the great features of the Roth 401k, is its high limits that you can contribute, while you’re employed  - it’s roughly three times more than a Roth IRA.  For 2010, you can squirrel away up to $16,500.  Furthermore, for those who are over 50 and starting late, there’s a “catch-up” plan which allows you to contribute an additional $5,500, totaling up to $22,000 per year.  This is great news for all you procrastinators out there.  Now you can start feathering your nest egg to a more respectable level.

For Roth IRA’s, you can contribute $5,000 if you’re under 50 years old, and if you’re over 50, you are allowed to contribute an extra grand – totaling $6,000.  However, the IRS says that your contributions can be reduced, depending on your modified gross adjusted income (MAGI).  The MAGI phase-out range is $105,000 – $120,000 for single filers and $166,000 – $176,000 for married filing jointly.   So essentially, if your income falls under these amounts your IRA contribution limits will be reduced accordingly.   On the other hand, if you make more than these amounts, you won’t be allowed to contribute either.

Required Minimum Withdrawals

The best thing about Roth IRA’s is that you can contribute virtually forever, as long as you’re alive, without any minimum required withdrawals (distributions).  It can be passed to your spouse or your kids and it gives tax-free earnings for them and next generations.  These contributions are still counted as income on your taxes, basically giving up the immediate tax benefit for a far more beneficial long-term tax benefit.

On the other hand, with a Roth 401K, you’ll have to begin withdrawal at 70.5 years old no matter what.  At that point, if you need the money then there is no problem.  But if you want to keep your savings tax free, there are ways around it by rolling over your 401K to the Roth IRA.  The one catch is that your withdrawals are taxed.

Matching Contributions

Since Roth 401k’s are offered by employers, they are eligible for company matching contributions.  Don’t forget to find out at work if your company offers matching contributions.  It’s free money, so don’t lose out on this opportunity.  Roth IRA’s are private accounts and cannot have any matching contributions, since you are the sole contributor.

Investment Options

With Roth IRA’s, you have much more control over your investments over Roth 401k’s, because you can chose from any kind of investments for your personal account, including individual stocks, bonds, mutual funds or real estate.  Roth 401k plans limit you to choose from the set of investments options offered by your employer.

If you can, it is worthwhile to max out your contributions with your Roth 401k and with any extra money you want to invest, and invest in a Roth IRA.  That way, if you prefer additional investment options that are not available through your employer, you can invest wherever you would like through a Roth IRA.