Roth 401 (k) vs. Roth IRA
What would you like to know
- Roth IRAs do not have RMD requirements, unlike Roth 401 (k).
- Unlike Roth IRAs, Roth 401 (k) have no income limit on the ability to contribute.
- The two types of Roth accounts can be used together to help achieve your client’s goals.
Roth IRA, Roth 401 (k) or both? It’s a choice that is confusing for many retirement savers and possibly some of your clients. In some cases, the answer may be that both are a good choice. In other cases, it could be either or maybe neither if a Roth account isn’t right for their circumstances and planning needs. Here are some things to consider.
What Are the Benefits of a Roth IRA?
Perhaps the greatest benefit offered by a Roth IRA is that they are not subject to the minimum required distributions. This can provide a number of planning opportunities for clients depending on their situation.
Not having to take RMD can be a powerful tool for retirement and estate planning. The ability to allow account assets to continue to grow tax-sheltered can help clients continue to accumulate retirement savings that can be withdrawn tax-sheltered as needed during retirement . This provides clients with tax diversification for their retirement savings.
The estate planning aspect is critical with the new inherited IRA rules for most beneficiaries other than the spouse under the Secure Act. Inherited Roth IRAs will pass tax-free to beneficiaries even with the ten-rule of the year as long as the original Roth IRA account holder had met the requirements of the five-year rule prior to his or her death.
A Roth IRA will allow a wider range of investment options than a Roth 401 (k), where the menu is limited by the options offered by the plan sponsor. This gives your client a lot more flexibility in terms of options such as individual stocks, ETFs, and mutual funds.
Roth IRA Disadvantage: Contribution Limits
The biggest drawbacks of a Roth IRA account are the income limits on the ability to contribute and the relatively low annual contribution limits. For 2021, the overall IRA contribution limit is $ 6,000, with an additional $ 1,000 of catch-up contributions available for those 50 and over at any time of the year.
The 2021 income limits for Roth contributions are:
- For those who report being single, the income phase-out begins at a modified adjusted gross income (MAGI) level of $ 125,000 with no authorized contributions to a MAGI greater than $ 140,000.
- For those who report married and spouses, the income phase-out begins at a modified adjusted gross income (MAGI) level of $ 198,000, with no authorized contribution to a MAGI greater than $ 208,000.
What are the advantages of a Roth 401 (k)?
Roth 401 (k) accounts, also known as designated Roth accounts, have become increasingly common. These accounts have many similarities to Roth IRAs, but also some differences.
Contributions to a Roth 401 (k) are made with after-tax dollars like a Roth IRA. Much like a Roth IRA, qualifying distributions made after age 59 and a half are tax exempt.
One of the biggest advantages of a Roth 401 (k) is that there is no income limit on your client’s ability to contribute to their Roth account in the plan. They can contribute up to the total amount of salary deferrals authorized for the current calendar year, regardless of their income level. For 2021, these limits are $ 19,500 for those under 50 and $ 26,000 for participants who are 50 or over at any time of the year.
If the client’s employer offers a match on a portion of the employee’s contributions, that’s another benefit of a Roth 401 (k) account. Employer money is free money and can be added to your client’s 401 (k) balance and overall retirement savings amount. By law, all employer matching contributions are made to your client’s traditional 401 (k) account.
Your client may be able to take out a loan on their Roth 401 (k) account if their employer’s plan has a loan clause. This can provide an additional degree of flexibility to be able to access their money in the plan if needed.
Another benefit that might benefit some of your clients is that the money in a 401 (k), Roth, or traditional account is usually protected from creditors. This can come into play if your client works in a profession subject to legal action. The protection against creditors of the assets in an IRA is much more limited.
Roth 401 (k) Disadvantage: RMD
A key difference between a Roth 401 (k) account and a Roth IRA concerns RMDs. Unlike a Roth IRA account, Roth 401 (k) account holders must take RMD of their account at the age of 72.
Customers who are employed when RMDs are supposed to begin may defer RMDs from their 401 (k) account with their current employer if they are not 5% or more owners of the business and their employer has made the appropriate choice.