Roth IRAs And Roth 401(k)s Aren’t The Same. Know The Important Differences

Many employers now offer Roth versions of their 401(k) plans. Though many people believe Roth IRAs and Roth 401(k)s (known formally as designated Roth 401(k) plans) are identical, there are important differences between the two types of retirement plans.

You know the basic differences between Roth-type accounts, and traditional IRAs and 401(k)s. In the traditional accounts, most contributions are either deductible (IRAs) or not included in gross income (401(k)s). Contributions to Roth accounts are included in gross income; you’re contributing after-tax money. Distributions from the traditional accounts are taxed as ordinary income, unless they are distributions of after-tax money. Distributions of income from Roth accounts are tax-free after the five-year waiting period.

But Roth IRAs and Roth 401(k)s aren’t exactly the same. You should know the differences. The knowledge will help you decide whether to open a Roth 401(k) or Roth IRA. It also might influence a decision of whether to keep money in a Roth 401(k) or roll it over to a Roth IRA.

Contribution Maximums

The contribution maximums of the two accounts are different.

The maximum IRA contribution is $6,000 in 2022 with an additional $1,000 catch-up contribution for those age 50 or older. But the maximum deferral to a 401(k), whether Roth or traditional, is $20,200 in 2022 with an additional $6,500 catch-up contribution allowed for those 50 and older.

Income Limits

There’s also an income limit for contributions to Roth IRAs. The maximum contribution begins to be reduced for a single taxpayer when adjusted gross income exceeds $129,000 and is reduced to $0 when adjusted gross income exceeds $144,000. For married couples, the phaseout begins at $204,000 and ends at $214,000 of adjusted gross income. There are no income limits for 401(k) contributions.

Employer Matching

Employers can make matching contributions to Roth 401(k)s just as they can with traditional 401(k)s. The maximum of combined employer and employee contributions is the same for both traditional 401(k) and Roth 401(k) accounts: $61,000 or 100% of the employee’s compensation (whichever is lower) in 2022 or $67,500 for those 50 and older.

But employer-matching contributions to a Roth 401(k) are pre-tax dollars. They won’t be included in your gross income and will be placed in a traditional 401(k) account. Distributions from that account will be taxed as ordinary income.

Investment Options

Most Roth IRAs can be invested in any publicly traded investment. But Roth 401(k)s can be invested only in the investment options available through the plan. A Roth 401(k) might have a brokerage window option that allows the account to be invested in almost any publicly traded investment.

Required Minimum Distributions

Many people don’t realize there’s a major difference in required minimum distributions (RMDs).

There are no RMDs for original owners of Roth IRAs. But there are RMDs for Roth 401(k)s starting at age 72, unless the account owner still is working for and owns less than 5% of the employer that sponsors the plan. These RMDs are tax-free, but you have to begin taking them.

Because of the RMD requirement for Roth 401(k)s, you might want to have one while working but roll it over to a Roth IRA before age 72.

You can take tax-free loans from a Roth 401(k) under certain circumstances. But you can’t take a loan from a Roth IRA — only distributions are allowed, and there will be a 10% penalty if they are taken before age 59½, unless you qualify for one of the exceptions.