Roth 401(k) vs. Roth IRA: What is the difference?

What is the difference between a Roth 401(k) and a Roth IRA? You probably heard of these two popular retirement plans but have never known what they mean or how they differ from each other. With the Roth 401(k) and Roth IRA, you make contributions with after-tax money, grow your accounts tax-free, and qualified distributions are tax-free. However, these two plans differ on how much you can contribute each year, the ways contributions are made, their benefits, and much more. To make sense of Roth 401(k) vs. Roth IRA, I put together this simple guide for you.

Here is everything you need to know about Roth 401(k) vs. Roth IRA.

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What is a Roth IRA?

A Roth IRA is a retirement account that allows you to make after-tax contributions. The Roth IRA does not give you upfront tax benefits. However, your account will grow tax-free, and qualified distributions will also be tax-free.

Unlike 401(k) plans that are sponsored by employers, the Roth IRA is not sponsored by an employer and you do not get an employer match. Instead, you open a Roth IRA from your bank, online brokerage company, or any other investment institution that offers retirement services.

The Roth IRA allows lower contribution limits compared to the Roth 401(k) plans. For 2024, the maximum contributions to the Roth IRA is $7,000 or $8,000 if you are 50 or older. For the Roth 401(k) plan, the contribution limits in 2024 are $23,000 or $30,500 if you are 50 or older.

Your eligibility to make contributions to an IRA will depend on your modified adjusted gross income(MAGI) and filing status.

What is a Roth 401(k)

A Roth 401(k) is an employer-sponsored retirement plan where contributions come from your after-tax wages through payroll deductions. The Roth 401(k) plan allows you to grow your account potentially tax-free and qualified distributions will not be taxed.

Your employer may also match your contributions to a Roth 401(k) which can increase your savings much faster. Keep in mind that your employer’s match to the plan will be before-tax contributions. For this reason, you will pay taxes on any employer match you received and earnings associated with them just like a pre-tax 401(k) plan.

Unlike a pre-tax 401(k) where you pay income tax on your distributions, the Roth 401(k) comes with tax-free withdrawals for every qualified distribution.

The Roth 401(k) is a hybrid between a Roth IRA and a pre-tax 401(k) and its characteristics are shared among these two accounts. For example, contributions you make to Roth 401(k) come from after-tax, you grow the account tax-free and pay no income tax on qualified distributions just like a Roth IRA. On the other hand, the Roth 401(k) is sponsored by an employer, contributions are made through payroll deductions, and it requires RMDs just like a pre-tax 401(k) plan.

Difference between Roth 401(k) and Roth IRA

Features	Roth IRA	Roth 401(k)
Account description	An individual retirement account(IRA) where contributions come from after-tax money.	an employer-sponsored account that allows you to save money for retirement with after-tax money
Contribution limits in 2024	$7,000 or $8,000 for those who are 50 or older	$23,000 or $30,500 for those who are 50 or older
RMDs rules	no RMDs requirements for the original account owner. Beneficiaries, however, must start taking RMDs following the death of the original account owner and the entire account must be distributed within 10 years. Some exceptions may apply.	RMDs are required when you turn 73. However, you can avoid them by rolling over your account in a Roth IRA.
Employer contribution	no	may contribute to the plan
Eligibility	based on your modified adjusted gross income(MAGI) and filing status	no income limit
Early withdrawal rules	unqualified distributions may be subjected to a 10% withdrawal penalty	unqualified distributions may be subjected to a 10% early withdrawal penalty
Account sponsored by Employer	no	yes
Types of contributions	after-tax contributions	after-tax contributions
Tax benefits	no upfront tax benefits but qualified distributions are tax-free.	no upfront tax benefits but qualified distributions are tax-free.
Taxes on distributions	you pay no tax on qualified distributions	you pay no tax on qualified distributions. Employer match and earnings they generated will be taxed.

Roth 401(k) vs. Roth IRA: Contribution limits in 2024

When it comes to making contributions, the Roth IRA and Roth 401(k) allow you to only contribute after-tax money. How much you can contribute to each account, however, is what makes the difference. The Roth 401(k) comes with higher contribution limits compared to the Roth IRA.

The following are contribution limits to both Roth IRA and Roth 401(k) plans.

Roth 401(k) contribution limits in 2024

The contribution limits to a Roth 401(k) in 2024 are:

$23,000 or
$30,500 if you are 50 or older. The extra $7,500 allowed for people who are 50 or older is called a “catch-up” contribution.

One of the benefits of employer-sponsored retirement plans such as Roth 401(k) is that the employer may also match your contributions up to a certain percentage. Most employers match your contributions dollar to dollar 3-6% of your income. Any employer match to your plan helps you grow your retirement savings fast.

With your employer’s match, the total contribution to your Roth 401(k) in 2024 cannot exceed $69,000 or $76,500 for those who are 50 or older.

Roth IRA contribution limits in 2024

The Roth IRA comes with much lower contribution limits compared to the Roth 401(k) plan.

Here are the Roth IRA contribution limits in 2024:

$7,000 or
$8,000 if you are 50 or older. The extra $1,000 contribution is a “catch-up” contribution allowed by the IRS.

The downside of this Roth IRA is that it is not an employer-sponsored account. This means you will not receive an employer match to the account. If you have multiple IRAs, the total contribution you can make to these accounts cannot exceed the contribution limits to an IRA in any given year.

For example, if you have a traditional IRA and a Roth IRA, the cumulative contributions to these accounts cannot exceed $7,000 or $8,000 if you are 50 or older.

Note: If your income is less than the limits allowed by the IRS on your Roth IRA or Roth 401(k), you can contribute up to the value of your income. For example, if you only made $5,000, the maximum contribution you can make to your Roth account will be $5,000 regardless of your age.

Roth 401(k) vs. Roth IRA: Early withdrawal penalty

When it comes to retirement, the rules are simple. The money you contribute to your retirement accounts must remain in the account until you have reached approved retirement age by the IRS. Accessing the money before retirement can lead to paying an early withdrawal penalty.

The Roth IRA and Roth 401(k) plan also come with a penalty for unqualified early withdrawals. Most retirement accounts including Roth IRA and Roth 401(k) plan require that you reach the age of 59½ before you take distributions. Any withdrawal you make before reaching this age will be considered early and a penalty may apply.

What is a qualified distribution?

To make a qualified withdrawal, the Roth IRA requires that you fulfill the following two conditions:

You must be at least 59½, and
Your account must be at least 5 years

Unless you meet the IRS exceptions, any withdrawals you make from your Roth IRA before you turn 59½ will result in a 10% penalty. Applicable taxes on earnings from your contributions may also apply.

The Roth 401(k) also requires that you reach 59½ before you can take distributions from the account to avoid a 10% early withdrawal penalty. Additionally, the account must be at least five years old to avoid applicable tax on the money that can be considered a gross income.

NOTE: Your contributions from either Roth IRA or Roth 401(k) can be withdrawn tax-free. This is because every dollar you contributed was already taxed.

Roth 401(k) vs. Roth IRA: RMDs

I cannot talk about Roth IRA vs. Roth 401(k) without emphasizing the required minimum distributions(RMDs).

RMDs are withdrawals required for some retirement plans when you turn the age of 73. Failure to take RMDs may result in a 50% penalty on the amount that was not distributed.

The Roth IRA does not have RMDs as long as the account belongs to the original account owner. However, beneficiaries are required to take RMDs after the original owner dies and the account must be distributed within 10 years. The Internal Revenue Service has exceptions to this rule and you can read about these RMD exceptions from this link.

One of these exceptions says that when the beneficiary is a surviving spouse or a minor child, RMDs will not be required.

Roth 401(k) vs. Roth IRA: Eligibility

For the Roth IRA, your eligibility is based on your modified adjusted gross income(MAGI) and filing status. When your income is higher than the acceptable level in any given year, you will not be eligible to make contributions to a Roth IRA for that year.

Here are the Roth IRA income limits in 2024.

If you are filing single or head of household and your income is less than $146,000, you can contribute up to the limit. Your contribution starts to decrease when your income reaches $146,000 until the amount you can contribute becomes $0 at $161,000.

On the other hand, if you are married and filing jointly and your modified AGI is under $230,00, you can contribute up to the limit. The amount you can contribute starts to decrease after your income hits $230,000 and becomes $0 when your income hits $240,000.

For the Roth 401(k), there is no income limit. The only condition is that your employer must have the plan and you must meet your employer’s eligibility requirements. This makes the Roth 401(k) a perfect plan for high-income earners to maximize their retirement savings.

Plan fees

The Roth 401(k) comes with more fees compared to the Roth IRA. While the 401(k) account management fees are a small percentage, they will cost you dozens of thousands of dollars over your lifetime.

On the other hand, Roth IRAs usually come with much lower account management fees. You can also shop around for lower fees across multiple brokerage companies and banks. This allows you to maximize your return on investment and grow your retirement nest egg fast.

Investment opportunities

The Roth 401(k) plan comes with investment limitations. Typically, you can pick any investment you want from the pre-selected investment option inside the plan. These limitations in investment choices can limit your return on investment on your Roth 401(k) plan savings.

The Roth IRA, on the other hand, allows you to pick any investment of your choice including mutual funds, Index funds, bonds, money management accounts, and individual stocks.

Should you choose a Roth 401(k) or Roth IRA?

Should you choose a Roth IRA or a Roth 401(K)? The answer to this question will depend on your financial situation. It is an individual thing.

The Roth IRA and Roth 401(k) plan require after-tax contributions. However, the Roth 401(k) allows almost 4 times in contribution limits than you can do with a Roth IRA.

The more money you contribute, the lower your after-tax paycheck becomes. So, if you can afford to stash away a lot of your after-tax money without having financial difficulties, choose a Roth 401(k). The Roth 401(k) will also be good for you if you want to reduce your tax liability during retirement. For example, if you are in a lower tax bracket and think you will earn more money in retirement, choosing a Roth 401(k) will be a wise decision.

The Roth 401(k) might also come with an employer match which makes it attractive.

The Roth 401(k) is also a great option for high-income earners. If you are not eligible to contribute to a Roth IRA due to having a higher income, the 401(k) will be your next choice since it has no income limitations.

Just like pre-tax 401(k), the Roth 401(k) will be managed and you will have less flexibility on investment options. If you want to have more freedom in investment choices and you don’t need to contribute a lot, then go with a Roth IRA.

Another great benefit of a Roth IRA over a Roth 401(k) is that it does not have RMDs. You can delay taking the money out as long as you want. If you choose a Roth 401(k), you can get away with RMD requirements by rolling over your account to a Roth IRA.