Roth 401(k)’s and Roth IRA’s – What You Need To Know

A reader asked if they could save into a Roth IRA and Roth 401(k). Learn what you need to know about the two types of Roth accounts.

Roth IRA’s were first introduced in 1997, and have steadily become a very popular retirement account. The term Roth refers to how contributions to the account, and growth within the account, are taxed. With Traditional IRA’s, you are able to take a tax deduction on any money you contribute. You will pay taxes on the money when you take it out of the account, presumably in retirement. When you contribute money to a Roth IRA, you are not allowed to take a tax deduction, but the money grows tax free and you can take it out in retirement without paying any taxes on growth.

Needless to say, the thought of having money grow in an account tax free is very tempting for many savers. Most of my clients opt for the tax free growth of a Roth IRA over the tax deduction that a Traditional IRA allows.

Roth 401(k)’s have been around a while, but are just now becoming popular benefit for employers to offer. Roth 401(k)’s work the same as Roth IRA’s, in that you can contribute money and pay the taxes today, and it will grow tax-free until you take the money out.

How much can you contribute to a Roth?

You can contribute $5,000 ($6,000 if you are over 50) to a Roth IRA for 2012. You don’t even have to do it this year – you can actually make the contribution for 2012 as late as April 15th of 2013.

You can also contribute $17,000 ($22,500 if you are over 50) to a Roth 401(k) for 2012. These contributions have to be made by the end of the year however.

One interesting note about Roth 401(k)’s is that employer matching contribution can NOT be put into your Roth account. Employer matching funds must be put into a separate account that works the same as a traditional 401(k), and is therefore tax deductible. This is just fine though, as it gives you some tax diversification in your retirement accounts.

So can I only contribute to one?

No! You can contribute to both a Roth IRA and a Roth 401(k). You can put away $22,000 ($28,500) combined into Roth accounts for 2012. And if you are married, you can put another $5,000 into a Roth IRA for them. A married couple that both have access to Roth 401(s)’s can save $44,000 into Roth accounts, or $57,000 if they are both over 50.  Being able to save THAT MUCH into a Roth account is amazing!

Just remember, you can save into a Roth IRA AND a Roth 401(k) in the same year. And if you have the ability to max out contributions into both accounts, then go for it. If you aren’t there yet, be sure you are taking full advantage of your employer match for your Roth 401(k) and maxing out your Roth IRA. You will be well on your way to a solid retirement plan.

So, did you know you could use both a Roth IRA and a Roth 401(k)? Have you been contributing to one but not the other? Please share in the comments section!

Alan Moore is a fee-only financial planner and founder of Serenity Financial Consulting in Shorewood WI. Follow him on Twitter @R_Alan_Moore. You can contact him at alan@serenityfc.com, 414-455-5313, or visit his website at www.SerenityFC.com. Want more education? Download your free guide to the “10 Easy Steps To Securing Your Financial Future Today.”

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North Shore Newbie October 09, 2012 at 08:27 PM
I thought that by definition a 401(k) used pre-tax money. If you can pay the taxes now and collect it tax-free, how is it different from a Roth IRA other than the fact the the employer offers it? Is that the only difference (and the fact that the employer may match)? Also, call me paranoid, but somewhere in the back of my mind I'm always worried that 15 years down the road some politician will try to "undo" what Roth did and go after our Roth IRA's by taxing our gains. They'll couch it in language that makes it sound like those of us who aren't taxed when we get our distributions aren't paying our "fair share". Where do you stand on that?
Alan Moore, MS, CFP® October 09, 2012 at 08:53 PM
North Shore Newbie, Great questions. Essentially, Roth 401(k)'s and the same as Roth IRA's in how they are taxed. Money going in is taxed, it grows tax free, and comes out tax free. The difference being how much you can contribute and income limitations (or lack there of with Roth 401(k)'s). One major difference is that Roth 401(k)'s are subject to RMD's while Roth IRA's are not (which may change at some point) so for those that want to leave the account to an heir, the Roth IRA may make more sense. The main thing I wanted to get across was that you can contribute to both, which isn't widely known. Your comment on the government changing its mind is well taken and is something I commonly hear. My crystal ball is as effective as everyone else's, so the short answer is that I don't know. Is it a possibility? Sure... But so are a lot of things that we entrust to the government. More likely, in my opinion, is that the government will simply stop allowing contributions to Roth accounts, but I don't see that happening for a while. I am not aware of any political push for this type of action.
Quietwood Guy October 10, 2012 at 02:37 PM
North Shore Newbie. I shared your concern about the future government tax promise and whether the government would maintain their promise. What gave me a little comfort is the IRS-government past practices where they grandfather certain tax treatments. For example, prior to 1982, after tax contributions to annuities (aka non-qualified annuities) when withdrawn were not taxed until your investment (cost basis) was exceeded, then the gain would be taxed as income. This was a pretty advantageous way to save for retirement similar to a Roth IRA. When they changed the rules on how retirement withdrawals are taxed they left a grandfather clause in for the contracts which where paid for prior to the rule change. This gave me comfort to trust the Roth IRA and Roth 401(k) for saving for retirement.


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