The first significant difference between investing in a Roth IRA versus a 401(k) plan is how you go about making contributions. The second significant difference between a Roth IRA and 401(k) is the tax treatment.
It’s also important to consider how employer matching contributions work within a 401(k) plan. Many firms have a matching policy; for example, 50% of the first 6% of contributions. That means, if you earn $100,000 and contribute $6,000 per year into your 401(k), your employer will pop in another $3,000 at no cost to you. That is an instant 50% return on your money in that scenario!
The IRS also allows you to take out earnings from a Roth IRA penalty-free in some situations. Some of the more common reasons to take the earnings out of a Roth IRA early include money for a first-time home purchase, qualified education expenses, qualified medical expenses, and for disability or death.
A Roth 401(k) works like a Roth IRA in some ways and like a 401(k) in other ways. We know that “Roth” means contributions are made after-tax. A Roth 401(k) is simply another employer-sponsored retirement account, but money in that account has already been taxed and will grow tax-free through retirement.
A Roth IRA differs from a Roth 401(k) in that contributions made to a Roth IRA can be withdrawn tax-free and penalty-free at any time. Inside a Roth 401(k), the plan participant faces a 10% early withdrawal penalty on withdrawals made before age 59½.
A Roth IRA also has a lower annual contribution limit than a Roth 401(k). According to the IRS, the maximum IRA contribution for 2021 and 2022 is $6,000 ($7,000 for those age 50 or older). The most you can put into a 401(k) plan is $19,500 in 2021 ($26,000 for those age 50 or older) and $20,500 in 2022 ($27,000 for those age 50 or older).
A Roth 401(k) does not have an income limit. For Roth IRAs, retirement savers should review rules determined by the IRS. High-income individuals and couples should forecast their adjusted gross income for the year before making Roth IRA contributions.