You may have heard of these accounts and their tax benefits, but they're not the same.
They get confused with each other ALL the time, so I'll highlight some key features and how to take advantage, especially if you are a high-income earner and want to maximize your retirement savings.
First, let's look at the main differences:
Both allow you to invest and build up money that can potentially be withdrawn tax-free at age 59 and a half, but a Roth 401k can ONLY be opened through an employer that offers this option. You can't go and open one on your own (unless you are self-employed). A Roth 401k also allows you to make much higher contributions than you can to a Roth IRA.
A Roth IRA you CAN open on your own, but it's subject to income limits. This means that if your income is above a certain threshold, the IRS will not allow you to make a direct contribution to a Roth IRA.
This is important to know because taxes and penalties can be assessed if you make an ineligible contribution.
You can contribute up to $7,000 annually (or $8,000 if you're over 50 years old) to a Roth IRA in 2024. However, these contributions are subject to the income limits shown below:
As you can see, Roth IRA contribution rules discriminate against those making higher incomes.
So what can higher income earners do to maximize tax-free savings? Enter the Roth 401k!
You can contribute up to $23,000 annually to a Roth 401k if you're under age 50. If you're 50 or older, that number rises to $30,500.
This is more than three times the Roth IRA contribution limit!
The great thing about Roth 401k is there are NO income restrictions. You can earn as much as you want and still make a FULL contribution to a Roth 401k.
Example:
This is a BIG advantage to those earning higher incomes over the Roth IRA limits and who want to maximize their tax-free retirement savings.
This will depend on how much you want to save a year, your annual income, and your tax strategy.
If your goal is to maximize tax-free savings and your employer offers a Roth 401k option, then it's a HUGE advantage, especially if you're receiving an employer match (that's essentially free money that you don't want to turn away).
You don't have to worry about income limits and can save more than three times the amount per year than you can in the Roth IRA. The good news is that most 401k plans now have the Roth option, although you may have to dig around on your 401k website portal to find it.
For high-income earners, the Roth 401k is even more of a bonus. If your MAGI is over the $240,000 threshold, it's the ONLY tax-free savings avenue the IRS is going to give you. It would be very wise to take advantage of it!
The only other option you have is doing "backdoor" Roth IRA contributions, but that's still only $7,000 per person annually ($8,000 if you're over 50).
If you don't have access to a Roth 401k, don't plan on saving more than $7,000 per year, or want the flexibility to remove your contributions for an emergency, then using a Roth IRA might be a better choice.
Yes!
You can max out your Roth 401k AND a Roth IRA as well. Assuming you want to turbocharge your retirement savings and are under the income limits for a Roth IRA, then you could contribute the maximum amount to a Roth 401k and the maximum to a Roth IRA in the same year.
Example:
While it may not be practical for everyone to save that much, the above scenario demonstrates the potential available for those who wish to take full advantage.
If your goal is maximizing tax-free savings for retirement, then Roth 401k is the most advantageous by far, especially for high-income earners.
Nothing else really comes close. The contribution allowance of $23,000 ($30,500 if over 50) in 2024 is over three times higher than for a Roth IRA. No income limits apply to Roth 401k contributions, and most 401k's receive an employer match. Hard to pass up!
If you don't have access to a Roth 401k, then a Roth IRA would be your next best choice, provided you are under the income limits to contribute.
Roth 401k and Roth IRA can both be used at the same time. You can make a maximum contribution to a Roth 401k and also make a maximum contribution to a Roth IRA in the same year (assuming you are under the Roth IRA income limits).
1.https://www.irs.gov/newsroom/401k-limit-increases-to-23000-for-2024-ira-limit-rises-to-7000
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