Thursday, August 12, 2021

Retirement Savings: Roth IRA vs. Roth 401(k)

Over the years, my relationship with money has transformed so that I feel really good about my money.  I honestly feel great about my plan, where I'm going, my ability to spend on current lifestyle desires, and my future.  When I consider what really makes me feel good about my finances, it boils down to one thing: choices.

I feel really great when I feel like I have a plethora of choices in front of me, plus I understand how to fold them into my lifestyle and financial plan.  Having choices that you understand can be incredibly empowering; though the opposite is true when the choices feel as though they need to be demystified, and you aren't sure which one to make.  Sometimes, a lack of understanding comes with an unfortunate case of paralysis.

I recently gave a series of workshops introducing attendees to a variety of retirement savings options including IRAs, 401(k)s, and 457 accounts all of which have both traditional and Roth options.  While I spelled out various attributes of these accounts in a general sense, I feel that there is still much to say where some of the finer nuances of these accounts are concerned.  Again, since I'm the Law of Attraction Finance Gal, unofficially titled of course, I am all about feeling really good about our choices.  Subsequently, I feel the need to zoom in on some of finer details by comparing some of these account options because it is in these finer details that we find the inspirations that inform our next actions.  So, this week we will be comparing and contrasting the Roth IRA with the Roth 401k.

History and Origins:

Roth IRA was born as a result of the Taxpayer Relief Act of 1997 and named after Senator Roth, it's chief sponsor.  The idea behind this retirement savings vehicle was to give investors no immediate tax advantage, but a rather large payoff on the back end.  Because taxpayers investing in Roth IRAs would not receive a tax benefit upfront, they would be entitled to tax-free growth over the course of the life of the account. In other words, the taxpayer wouldn't have to pay any taxes on the funds (both their contributions and the growth) in retirement.  A few short years later, in 2001, the Roth 401(k) was also born having many some commonalities with a Roth IRA but others with the Traditional 401(k).

Income Limits:

When the Roth IRA was first conceived of, the IRS imposed an income limitation that did exclude some people from being able to take advantage of this account type.  This income limit changes every year and varies by tax filing status.  As of 2021, the income limit is $140,000 for single filers; $208,000 for those married filing jointly.  The restrictions for those that are married filing separately are significantly more strict, making it difficult for those filers to utilize a Roth IRA at all.  In recent years, a "workaround" to the income restriction has been introduced and it's called a "back door Roth IRA."  This allows people that earn more than the IRS restriction allows to contribute to a Roth IRA through a backdoor.  People basically contribute to a traditional IRA and roll it immediately to a Roth, paying the taxes in the current year. It's a roundabout way, but completely effective and legit. Anyone that is in this boat should do further research and might consider professional assistance to be sure they take the correct steps for this transaction. But, the key point here is that it can be done!

A Roth 401(k) on the other hand doesn't have any income restrictions.  So, it can be a really great option for high-income earners.

Annual Contributions:

There are limits to what can be contributed to both Roth IRAs and Roth 401(k), although those limits are not the same.  

In 2021 the IRS allows people to contribute $6,000 to a Roth IRA.  Investors aged 50+, are allowed what is called a "catch-up contribution." This allows them to contribute an additional $1000 annually.  This way, as Americans inch closer and closer to retirement, they can contribute more in order to "catch up" if they'd like. 

The contribution limits for Roth 401(k)s align with that of traditional 401(k)s.  In 2021, plan participants can contribute up to $19,500 to a Roth 401(k).  There is also a catch-up contribution available for those ages 50+, but it's a fair amount higher.  The catch-up contribution for a Roth IRA in 2021 is an additional  $6500 annually.  

Now, it's important to know these contribution limits are subject to change annually for both Roth IRAs and Roth 401(k)s.  They frequently go up something to the tune of $500 annually when increased.  So, you should double-check these numbers periodically.


You can't really take a loan against a Roth IRA, but it's pretty much unnecessary. You can basically take your own contributions out any time you want. Just don't touch the earnings.  That's the part that will get you into trouble.  If you touch the earnings before you're allowed, you will incur a penalty. Nobody needs that.

A Roth 401(k) will allow plan participants to take out a loan.  There is a restriction on the dollar amount thought.  You can technically take out 50% of the account balance or $50,000 whichever is smaller.    Big warning here!  If you fail to repay according to the loan terms, this becomes a taxable distribution!  Sounds messy, right?

In general, I'm not at all an advocate of taking money out of retirement for reasons other than retirement.  But, I am presenting you with the information to do with as you please.

Required Minimum Distribution (RMDs):

A Required Minimum Distribution or RMD is basically the IRS forcing you to start taking the money out at a certain point in time.  In order to understand the concept, think about a traditional IRA or 401(k).  The government gave you the tax break and has gotten their cut yet!  So, at some point, Uncle Sam is standing there impatiently tapping his foot with his hand stuck out, demanding his share.  He only gets his share when you take your money back out.  So, he's going to require that you do so.

There is no RMD with a Roth IRA.  So, if you don't use the money, you can leave it to your heirs.  If this is something you plan to do, I would highly recommend seeking professional guidance on the best strategy for doing this, but know that it's an option!

Now, technically, there is an RMD with a Roth 401(k).  You are required to begin taking distribution by age 72 (it used to be 70 1/2, but that recently changed); however, there is a loophole (2 in fact)!  First off, if you are still working when you are 72 and not a 5% owner of the company for which you work, you might be able to avoid RMDs, and should contact the plan administrator for additional info.  The second loophole and this is a BIG one, involves rolling the Roth 401(k) over into a Roth IRA. Since the Roth IRA doesn't have an RMD, once you've done so, you're golden.  Also, you shouldn't have a tax bill for doing so because you already paid the taxes, right?  Easy peasy.  I would still say to have a professional help you with something like that just to make sure you cover all necessary bases.

Investment Options:

Many investment professionals will tell you to invest in a Roth IRA first because quite frankly, the world is your oyster where investment options are concerned. You simply use any discount brokerage firm to open the Roth IRA and then invest in literally anything you want!  This is not the case with a Roth 401(k).  Since Roth 401(k)s are employer-sponsored retirement plans, you will only be allowed to choose from the investment options they have selected from you. Oftentimes, they also have higher administrative fees.

Early Distributions:

In general, the age 59 1/2 is the magic number when it comes to taking retirement distributions.  This is the minimum age the IRS allows you to be "qualified" to take money out for your retirement without incurring a penalty (or taxes with traditional accounts).  That being said, there are some nuances that are slightly different with different account types.

As previously stated, you can take your own contributions out of a Roth IRA whenever you like.  So, you don't particularly need to be 59 1/2.  However, that only applies to the money you put into the account. If you touch the growth prematurely, you'll be subject to a 10% penalty.  There are a few exceptions to this of course.  There are exceptions if you've held the account for 5 years or more.  They're things like a first-time home purchase, etc.  So, look those up if you think they apply to you.  To be clear, you'd probably want to spend a little time reading about "exceptions" as well as the "5-year rule."  

If you take money out of a Roth 401(k) early, you can expect to incur a 10% penalty.


I feel constantly inspired to find ways to save for my retirement, but I recognize that this inspiration can only come when a certain amount of knowledge, understanding, and a vision for my future are present.  So, I hope that this comparison of Roth IRAs to Roth 401(k)s has proven useful, and you too are feeling inspired to save money so that you can continue to create and live the life you are meant to live.  

If there are any other tips or rules about Roth 401(k)s or Roth IRAs that you feel I've forgotten, feel free to mention them in the comments.  Subsequently, I am open to questions or suggestions for a future post.  Next week, I plan to zoom in on the comparison of a 401(k) to a 457 account.  Stay tuned!

For Further Reading:

My 3 Bucket Approach to Retirement Savings

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