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

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 15^th 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.”