Roth 401k vs Roth IRA?

Sometimes it's best not to choose. Invest in both your company's Roth 401(k) and a Roth IRA.

Roth 401k vs Roth IRA?

It’s best not to choose.

Contribute to both on a yearly basis

for these 4 reasons:

Reason #1:

You may think if you’re offered a Roth 401(k) option at work, why bother with a Roth IRA? One big reason is accessibility. The money in your 401(k) is pretty much locked up until you turn age 59 1/2.

Yes, you can take a hardship withdrawal or loan money from your 401(k), but the former comes with tax and a possible 10% early withdrawal penalty, while the latter wallops you with double taxation.

The money you contributed to your Roth IRA over the years is accessible at any time for any reason with no tax or penalty. I’ve found a lot of folks don’t know this. (Maybe they’re better off not knowing?)

You don’t have to be 59 1/2 or even have a good reason. Just don’t withdraw more than the total of your past yearly contributions.

Example: Kat is 35 and has been making yearly $5,000 contributions to her Roth IRA for the last 5 years. Her account balance is currently $35,000. Kat could take her $25,000 of past contributions out of her Roth IRA tax and penalty free to pay for a Master’s degree, help fund a house purchase, pay off high credit card debt, or go on a very expensive holiday.

Those $10,000 of earnings, however, must stay in her account for another 24 1/2 years if she wants her withdrawals to be tax and penalty free. Visit Roth IRA early withdrawal for the details regarding taking money out early.

Reason #2: Higher contribution limits and no income limits

The 401(k) contribution limit is much higher than Roth IRA contribution limits. You can contribute over 3 times as much money per year to a Roth 401k vs Roth IRA.

Plus, if you want to contribute more money than your 401(k) plan allows, your Roth IRA gives you that option.

Keep in mind that a Roth IRA has agi limits, meaning that if you make too much money, you can’t contribute directly to a Roth IRA. 401(k) plans have no such agi limitations.

By the way, there is a way around those income limits for Roth IRAs if you’re a higher wage earner. It’s a little trick I call the Roth IRA Switcheroo.

Reason #3: No Required Minimum Contributions

When it comes to comparing a Roth 401k vs Roth IRA, there is another huge reason why you need both: Roth 401(k)s are subject to required minimum distributions (rmds), while Roth IRAs are not subject to rmds.

Even though no tax liability will be due, rmds apply equally to both your taxable and non-taxable cash in your 401(k) when you reach age 70 1/2.

This is easily avoided by rolling over your Roth 401(k) contributions and associated earnings into your Roth IRA once you separate from service from your employer.

Reason #4: Take Advantage of Employer Contributions

Not all employers offer a match or non-elective contribution, but if they do it’s important that you have your 401(k) plan up and running. Otherwise, that money your employer is trying to give you for your retirement will be lost – forever.

Some employers offer a match, but only allow you to make traditional or pre-tax contributions. If you’d rather make Roth contributions, contribute just enough to your company plan to get your full match, then stash the rest of those retirement dollars in your Roth IRA (see reasons 1 & 3).

If you still want to contribute more than the Roth IRA contribution limits allow, increase your contribution percentage in your 401(k) in addition to maxing out your Roth IRA.

There’s just one instance where you’d only want to make Roth IRA contributions and shun your company’s 401(k) altogether: That’s if your company offers no match and you aren’t planning on investing more than the Roth IRA contribution limits allow.

Roth 401k vs Roth IRA?

Roth 401k vs Roth IRA? There’s no need to decide. Most likely it makes sense for you to have both working for you.

If you have a sound investment plan and a long time horizon for investment, you can’t get enough tax free earnings!