In 1975, Congress introduced the Individual Retirement Account (IRA) as the first tax-advantaged retirement savings tool. Even though it is an incredibly popular option for saving for retirement, many people don’t quite understand how it all works.
So what is the difference between a Roth IRA and a Roth 401(k)? Well for starters it all depends on how much money you make. Let’s dive into which one may be the right fit for you.
ROTH IRA
Advantages:
A Roth IRA has been around since 1997, and is funded with after tax dollars. That makes qualified distributions tax free. It also does not require you to take RDM’s (required minimum distributions) at any point. This means you can keep contributing to the account and let the monies continue to grow. You could leave it to your spouse or to any heirs if you pass away, as long as you do not let the account pass through probate. Roth IRA also has a huge range of investment options for you to choose from. You can also, with a Roth IRA, withdraw an amount equivalent to the contributions you have put into it at any time without penalty IF you have had the account for under five years. This does NOT apply to the earnings on the account. If you withdraw, pre-retirement(under 59 ½ ) , you’re looking at a 10% penalty. Now there are situations where this can work to your advantage, such as, if you are buying your first home, you want to pay for kids/grandkids to go to school, medical costs, you could then withdraw earnings from your account free of any penalties, but not taxes, if you’ve held it for under five years, but free of penalty AND taxes if you have held it for more than five years.
Disadvantages:
Roth IRA’s unfortunately do come with an income limit. Persons who make more than $140,000 in 2021 or married couples making more than $208,000 are not eligible for Roth IRA contributions. The contribution limit for Roth IRA’s is also lower. $6,000 per year compared to $19,500 for a Roth 401(k) for 2021. You also cannot get a loan from your Roth IRA. However, you can initiate a Roth IRA rollover. You’ll have 60 days to move your money from one account to another, and as long as you return the monies OR move it to another Roth IRA account you will essentially be getting an interest free loan for 60 days. But beware of any penalties and tax implications if you fail to do this!
ROTH 401(K)
Advantages:
Roth 401(k)’s began in 2001. They are like traditional 401(k)’s in that they are offered through employers, can be matched, contributions can be made directly from your paychecks and are not subject to income taxes. There is no income limit with a Roth 401(k), which means people with higher gross incomes can contribute. It also has a higher contribution limit than the Roth IRA. You can contribute an annual maximum of $19,500 for 2021 plus a $6,500 catch up contribution if you turn 50 by the end of 2021. Don’t forget those matching contributions from your employer! Don’t leave this money on the table if your boss is offering this opportunity, free money is free money. The catch to this is however, because the match is pre-tax dollars, and the Roth is funded with post-tax dollars, the matching funds and earring will be placed in a regular 401(k) account. That means paying taxes on all monies, and earning, once distributions start being taken. You can take a loan from a Roth 401(k) by borrowing up to 50% of the account or $50,000, whichever is smaller. Be sure to pay this back, because if you don’t it will be considered a taxable distribution.
Disadvantages:
The dreaded RMD’s (required minimum distributions). With a Roth 401(k), you do have to start taking RMD’s when you hit 72. If you don’t expect a stiff penalty. You are also limited to what type of financial investments you have to choose from. Usually you’ll have to choose from what your financial administrator at your job has for you to decide from. And that is more than likely only a handful of basic mutual funds. Also, you won’t be able to access your Roth 401(k) before age 59 ½ without incurring a 10% penalty.
When it comes to whether a Roth IRA or a Roth 401(k) is the better account for you, it really is going to be a matter of personal choice. One is not better than the other. The right financial advisor can help you decide which one is right for you and can help you with your long term financial goals. Call Coach Peter D’Arruda and his team at Capital Financial now and let them put you on the right road to retirement.