What Is The Difference Between Roth IRA And Roth 401k?

Saving for retirement is very much a part of an individual’s personal and career goals. People have widely different ideas about what they want to do at the end of their regular working lives. For instance, some may wish to retire early, others would prefer to continue working for as long as they can but not at a full-time job that would fetch them a large income. Some look forward to leisure to pursue a hobby, travel, purchase another home or a boat, or to ensure that they and their partner don’t have to be financially depend on anyone, or they may even want to leave a substantial legacy for their children and grandchildren.

Whatever your goals, the money you save is subject to the vagaries of economic factors, how long you actually live and the medical and care costs you incur. 

Financial experts advise that you should start saving as early as possible for your retirement. Based on the standard of living you hope to achieve in your senior years, you should try to save 10-15% of your income.

Contributing to retirement funds if you start in your 20s gives you a good 40 years to build a sizable nest-egg. 

Retirement Plans

Today, a large proportion of the workforce finds itself responsible for making its own contribution to retirement funds. Whatever the nature of your work or the amount you earn, it’s wise to save something out of it as soon as possible. 

The saving habit should be cultivated and learned early, with parents teaching their children its value. When your savings are invested wisely and cautiously in the right investment products, you can grow and increase their value significantly since you have the time to do it. 

There are several diverse retirement savings plans available to choose from because there is no one-size-fits-all formula:

  • 401 (k)
  • Roth 401 (k)
  • Solo 401 (k)
  • 457 (b)
  • 403 (b)
  • Simple IRA
  • IRA
  • Roth IRA
  • HSA 
  • Rollover IRA
  • Conduit IRA

What Are IRAs?

IRA or Individual Retirement Account is a tax-advantaged way to save money for your retirement. It is set up within a financial institution and enables saving for retirement on either tax-free or tax-deferred accounts. This term can be used to describe individual retirement plans, trusts, custodial accounts, individual retirement annuities, etc.

There are certain conditions attached to IRAs:

  • Only cash or cash equivalents can be used to fund them
  • Certain notified types of income cannot be used to contribute to IRA
  • There are limitations to the total annual contribution
  • Income thresholds depend on the income-earning capacity of the spouse
  • Federal protection of IRA is allowed in case of bankruptcy
  • Borrowing from IRA accounts is not allowed except for a two-month period in a single calendar year
  • There are varying rules regulating the inheritance of an IRA account after the death of the account holder

What Are 401 (k) Accounts?

401 (k) accounts are those offered by employers and they may match your contributions by a certain percentage. The amount contributed to the 401 (k) account is reduced from your taxable income. At age 70.5, the account holder must start withdrawing funds and these withdrawals are taxed. If a person takes money out from the account before age 59.5, penalties are imposed. 

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Roth Accounts

Roth accounts are those retirement accounts that are held within an IRA plan or a 401 (k) plan.

Roth IRAs are retirement plans that mandate that taxes are paid on all money that goes into the account, but they enable the account holder to withdraw qualified amounts that are tax-free. They are beneficial for people who feel that their post-retirement taxes will be higher than they are at present. 

However, there is a limit to how much you can contribute to a Roth account – it is $139,000 for single people and $206,000 for married partners. As long as the account holder can show earned income, they can hold the account indefinitely and continue to make withdrawals throughout their lifetime. The account can be funded via regular individual or spousal contributions, transfers, conversions, or rollover contributions. 

Only cash contributions are allowed and not securities or assets. Once the funds are available in the account, there are several investment options available. 

The Difference Between Roth IRA and Roth 401 (k)

It’s good to know the difference between Roth IRA And Roth 401k to make the best financial decision. You can hold both types of accounts simultaneously, provided the Roth 401 (k) is offered by your employer. 

The biggest difference is that Roth IRA is opened, operated and controlled only by the account holder/custodian appointed by them, whereas Roth 401 (k) comes under the general umbrella of the overall 401 (k) plans offered by employers, or it can be availed of under the Solo 401 (k) if you are a self-employed person. 

Withdrawals from both types are tax-free based on certain criteria. 

To get a better understanding, it’s good to know the features of both: 

Roth 401 (k)

  • 70% of companies in the US offer a Roth 401 (k) plan
  • It is designed mainly for those who are in a higher income earning bracket
  • Has higher contribution limits
  • Enables matching employer contributions.  
  • Great blend of the Roth IRA and the traditional 401 (k)
  • Beneficial because it has no income limit
  • Employers are offered tax benefits when they match the account holder’s contribution
  • You can avail of loans up to 50% of what is available in your account, or $50,000 whichever is lower
  • Access to your funds is restricted until age 59.5
  • However, you must start withdrawing from the account when you reach age 72 or face penalties
  • Investment options are limited

Roth IRA

  • Funded with after-tax dollars
  • No minimum withdrawal age as with Roth 401 (k) where you have to start drawing from the account at age 72
  • There are prescribed income caps that limit your ability to contribute directly to the account
  • Subject to $6000 annual contribution limit with an additional $1000 for those above age 50
  • The first Roth IRA account that you open should have been open for a minimum of five years before withdrawals can happen
  • You can withdraw funds based on certain criteria
  • You have more control over the kind of investments you can make
  • There is more flexibility, especially if you plan to leave a legacy for heirs
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