getty
Many employers now offer Roth versions of their 401(k) plans. Although many people believe that Roth IRAs and Roth 401(k) accounts (formally known as designated Roth 401(k) plans) are identical, there have been important differences between the two types of retirement plans. But one major difference was removed at the end of 2022 when the law known as the SECURE Act 2.0 was enacted.
Learn the basic differences between Roth accounts and traditional IRAs and 401(k’s). In traditional accounts, most contributions are deductible (IRA) or not included in gross income (401(k)s). Contributions to Roth accounts are included in gross income; you are contributing money after taxes. Distributions from traditional accounts are taxed as ordinary income, unless they are after-tax distributions of money. Income distributions from Roth accounts are tax-free after the five-year waiting period.
But the Roth IRA and Roth 401(k) are not exactly the same. You should know the differences. The knowledge will help you decide whether to open a Roth 401(k) or a Roth IRA. It could also influence the decision to keep the money in a Roth 401(k) or roll it over to a Roth IRA.
The maximum prices of the two accounts are different.
The maximum IRA contribution is $6,500 in 2023 with an additional $1,000 catch-up contribution for people age 50 and older. But the maximum deferral to a 401(k), either Roth or traditional, is $22,500 in 2023 with an additional $7,500 catch-up contribution allowed for people age 50 and older.
There is an income limit on contributions to Roth IRAs. The maximum contribution begins to decrease for a single taxpayer when adjusted gross income exceeds $138,000 and decreases to $0 when adjusted gross income exceeds $153,000. For married couples, the elimination begins at $218,000 and ends at $228,000 of adjusted gross income. There are no income limits for 401(k) contributions.
The SECURE 2.0 Act made a major change to catch up with contributions to employer plans like 401(k)s. Catch-up contributions will be treated as Roth contributions after 2023 when made by an employee whose wages from that employer in the prior year exceeded $145,000. The amount is indexed for inflation. The treatment applies whether the employee is making contributions to a traditional 401(k) account or a Roth 401(k) account.
This means that those catch-up contributions will be included in the employee’s gross earnings for the year.
That change applies only to employer plans, not IRAs. Also, it applies only if the plan allows all participants to choose whether catch-up contributions and other elective deferrals will be treated as traditional contributions or Roth contributions.
Employers can make matching contributions to a Roth 401(k) just as they do a traditional 401(k). Maximum combined employer and employee contributions are the same for traditional 401(k) and Roth 401(k) accounts, $66,000 or 100% of employee compensation (whichever is less) in 2023 or $73,500 for people older than 50 years.
Prior to the SECURE 2.0 Act, employer matching contributions to a Roth 401(k) were always pre-tax dollars. They were not included in the employee’s gross income and were placed in a traditional 401(k) account. Distributions from that account were taxed as ordinary income.
The SECURE 2.0 Act allows employer plans to provide an option in which plan participants can choose whether matching contributions are treated as traditional or Roth plan contributions. The employer does not have to offer this option, but is allowed to do so. The 401(k) must be amended to allow the option.
Most Roth IRAs can be invested in any publicly traded investment. But Roth 401(k)s can be invested only in the investment options available through the plan. A Roth 401(k) may have a brokerage window option that allows the account to be invested in almost any publicly traded investment.
Before the SECURE Act 2.0, there was a big difference in lifetime RMDs between Roth IRAs and Roth 401(k)s. The original owners of Roth 401(k) and Roth 403(b) accounts were required to take RMDs during their lifetime under the same rules as for traditional accounts. This was a big difference between Roth IRAs and employer-sponsored Roth accounts.
After 2023, the RMD requirement for original owners for employer-sponsored Roth accounts is removed. They will be on par with Roth IRAs. Beneficiaries who inherit Roth IRAs or employer-sponsored Roth accounts will still have to take RMDs.
You can borrow tax-free from a Roth 401(k) under certain circumstances, but you cannot borrow from a Roth IRA. You can only take distributions from a Roth IRA and there will be a 10% penalty if taken before age 59½, unless you qualify for one of the exceptions.
