Traditional 401(k), Roth IRA, traditional IRA, Roth 401(k)—with so many options, how do you know which one is best for you?  Anyone who knows me well knows the answer I’m about to give:  “It depends!”

Long-time readers have seen this recurring theme throughout RetireWire.  Depending on your financial situation and on what stage of life you’re in, one account will be (or MAY be) more beneficial than the other.  The one commonality among these tax-advantaged retirement plans is that they can serve as a great way to get started saving for retirement. 

To appreciate the differences between the two Roth accounts featured in the title of this blog post, we must first understand the differences between traditional tax-advantaged accounts and Roth accounts. 


Choose your retirement savings accounts wisely!

Take your time and do your research. Choosing the right type of account for your retirement planning makes a huge impact on your financial success.

Roth Versus Pre-Tax Accounts

Traditional 401(k)s and IRAs offer short-term advantages AND long term retirement savings benefits.  They reduce the tax you pay now – hence the short term advantage. 

In both plans/accounts, money grows tax-deferred until you withdraw it. At that point, withdrawals are taxed as ordinary income to the account holder.

Roth accounts, on the other hand, accept only post-tax contributions.  There’s no tax break up front, but you eventually get to withdraw the money tax-free. So you can make pre-tax contributions to an IRA or 401(k), and only AFTER-tax contributions to any form of Roth account (Roth IRA or Roth 401(k)).

Now we’ll explore the similarities and differences between the Roth IRA and the Roth 401(k), specifically pertaining to 6 important categories:  contribution limits, income limits, fees, investment options, employer matching, and withdrawal requirements.

For a quick breakdown of IRA’s versus Roth IRA’s, click here.


How Much Can You Put Into Your Pre-Tax IRA/401(k) vs. Roth IRA/401(k)?

The Roth 401(k) offers you the ability to contribute a higher amount yearly to your tax-advantaged account.  The 2018 maximums allow you to contribute up to $18,500 to your Roth 401(k), compared to the Roth IRA which maxes out at $5,500.  A unique feature of the Roth accounts allows you to make “catch up” contributions once you reach the age of 50.  Again, the Roth 401(k) tops the Roth IRA, allowing $6,000 worth of catch up contributions versus just $1,000.

Advantage:  Roth 401(k)


Income Limits To Make A Contribution

Since the Roth 401(k) lacks an income limit pertaining to contribution eligibility, it’s favorable for high earners.  For 2018 the income limit to make a Roth IRA contribution phases down from $5,500 to $0 as your income (married filing jointly) expands from $189,000 to $199,000.

So if your joint income is more than $199,000 you can’t fund a Roth IRA. Many people who would not be otherwise eligible to fund a Roth IRA CAN indeed fund their Roth 401(k) however.

Advantage:  Roth 401(k)

Fees & Expenses

Long-time readers know I’m a huge supporter of lower fees.  A Roth IRA account can be opened at a brokerage that charges low fees, and it also offers you the ability to choose no-load funds.  Meanwhile, in your Roth component of your 401(k) plan you may or may not enjoy low fees.

Smaller 401(k) plans typically aren’t super cheap, in fact if they’re buried with high cost insurance products you may be better off investing in a regular taxable account! Big companies typically have highly diversified 401(k) plan options and substantially lower costs due to the buying power millions of dollars brings to the table.

Advantage:  It depends on how good your 401(k) plan is!


Investment Options

While the Roth 401(k) is limited to group funds, the Roth IRA offers a much broader range of possibilities.  You can invest in almost any stock, bond, or mutual fund.

Your 401(k) at work will be limited to what the investment manager(s) and your company plan sponsor/investment committee approve. While they may select great investments, they may also select high cost poor performing investments. This all depends on the quality of your 401(k) plan.

To get the broadest amount of investment options available, open your Roth IRA with one of the leading custodians. Schwab, TD Ameritrade, and Fidelity come to mind as great options. Through those custodians you should have access to a very broad range of mutual fund investments.

Advantage:  Roth IRA (usually)


Employer Matching Contributions

The Roth 401(k) offers employer matching, while the Roth IRA does not.  One important factor to note is the Roth 401(k) exemption.  If your employer makes matching contributions, they are considered to have been made pre-tax, not post-tax. 

Any matching contributions from your employer will be placed into a separate account and treated as a traditional 401(k) account from a tax perspective.  You’ll remember from the beginning of this article that the traditional 401(k) reduces the tax you pay now, but is taxed as ordinary income upon withdrawal. 

Advantage:  Roth 401(k) (because at least you can potentially get an employer match even if it is taxable when you withdraw funds)


Withdrawal Requirements

You may have heard of the term “Required Minimum Distributions”. This term – RMD – describes the IRS requirement that you start withdrawing some of your pre-tax retirement savings each year from when you turn 70 and 1/2 until when you die. This ensures that the government will get it’s tax dollars at some point while you’re retired.

The Roth IRA has no minimum withdrawal requirements.  The account can even be passed down to your heirs, giving them a tax-free withdrawal which can be stretched out over their lifetime. 

The Roth 401(k) has required minimum distributions (RMDs) that start at the age of 70 1/2.  However, you can avoid these RMDs by converting your Roth 401(k) into a Roth IRA, which is another whole blog post in itself.

Advantage:  Roth IRA


PRE-tax IRA or 401(k) Versus NO-Tax Roth IRA or Roth 401(k)

As you can see, each account offers advantages and disadvantages in different areas. From a pure tax standpoint, higher earners now may lean towards the current tax savings with the pre-tax IRA or 401(k). When they retire they’re likely going to be in a lower tax situation, so the tax-deduction now is quite important.

Lower income earners should definitely opt for the tax-free Roth IRA. The tax break now (at their lower tax bracket – say 25% or less) isn’t worth as much as the tax-free growth on the Roth IRA which will eventually be distributed tax-free upon withdrawal (assuming they abide by the normal rules).

You should assess which areas impact your financial well-being the most and proceed from there.  It should be noted that it’s possible to contribute to both, which is especially advantageous if your employer offers matching options. 

For most retirement savers, starting with a combination of Roth IRA/Roth 401(k) contributions AND mixing those with pre-tax contributions to an IRA or 401(k) makes a great deal of sense! While it may not be 100% perfect, you’ll enjoy the benefits of entering retirement with a great deal of flexibility in how you draw your retirement funds down over time.