Choosing Between a Roth IRA and a Roth 401k
Roth accounts are best known for their tax-free withdrawals. All withdrawals from a Roth account are tax-free if the participant is at least 59 ½ years old and the account has been held for five years.
This is advantageous for:
- Those who expect to be in a higher tax bracket at the time of withdrawal
- Those who expect that tax rates may be higher in the future
- Those who want to prepay the tax liability on their retirement accounts
Once you decide that a Roth is for you, how do you choose between a Roth IRA and a Roth 401k? You’ll want to compare the following:
Features of a Roth IRA
- Contribution limits for the Roth IRA are $5,500 for those under the age of 50 or $6,500 for those age 50 and above in 2013
- Required minimum distributions (RMD) are not required for the Roth IRA
In other words, you are not required to take withdrawals from the account. You can opt to not withdraw at all, leaving the funds to grow uninterrupted. Another choice is to leave the full amount to beneficiaries, tax-free.
- Contributions are restricted by income limit
If your income is higher than the limit, you can maintain the account, but not contribute to it. If you make $112,000 Modified Adjusted Gross Income (MAGI) as a single filer or $178,000 MAGI as a joint filer, you cannot contribute to a Roth IRA.
- You can reverse Roth conversions in part or total through the Roth IRA’s annulment option
Conversion to Roth IRA can take place once the participant leaves the company and is 59 ½.
- Withdrawals can be tax-free
You can withdraw direct contributions at any time without tax penalty. In addition, you can withdraw rollover amounts after the account has been held for five years. Earnings can be withdrawn after age 59 ½ and the five year holding period.
Features of a Roth 401k
- Contributions for the Roth 401k are significantly higher than the Roth IRA
In 2013, the contribution limits are $17,500 for those under age 50 and $23,000 for those age 50 and above.
- Required minimum distributions (RMDs) must be taken
Participants who are 70 ½ and still employed at the adopting company do not have to begin taking distributions from the plan. RMDs begin however, once the participant retires from the adopting company.
- No income limits for making contributions
You can contribute to the plan, without an income limit.
- Conversion to a Roth 401k is available at any time and at any age
You are not restricted from converting by age. And all or part of a traditional 401k can be converted to a Roth 401k. There is no annulment option for a Roth 401k conversion.
- Greater creditor protection with the Roth 401k
As an employer sponsored plan, the Roth 401k can offer more protection against lawsuits and bankruptcy creditors.
- The Roth 401k may have a loan feature, depending on the plan sponsor
You can borrow from your 401k if it has a participant loan feature. You cannot borrow from IRAs, period.
With the participant loan feature, you can borrow from your 401k. You can use the funds for any purpose, once it is in your account, and you pay back your 401k with interest. Check with your Roth 401k sponsor if the plan has this feature.
Both the Roth IRA and the Roth 401k have different advantages and features. The choice depends on your circumstances and retirement goals.