The option to use Roth versions of employer 401(k), 403(b), and 457 retirement plans are becoming more prevalent in recent years from both public and private employers. While these Roth employer plans share much in common with Roth IRAs, there are important differences to be aware of.
Similarities between Roth IRAs and Roth employer plans
Neither Roth account benefits from an income tax deduction on contributions made into the account. This is a significant difference from traditional tax-sheltered retirement plans where contributions are income tax deductible, typically in the year in which they are made. In both Roth IRA and Roth plans, all appreciation, interest, and dividends accumulate on a tax-deferred basis, so long as the assets are not withdrawn from the account.
Additionally, Roth plans have the ability to draw tax-free income in retirement, provided you meet two conditions:
- You have reached age 59 ½ and
- You have participated in the plan for a minimum of five years prior to the time distributions are taken.
Finally, if withdrawals are taken from Roth accounts prior to age 59 ½ or within five years of original contribution, only the earnings are subject to ordinary income tax and a 10% early withdrawal penalty. The contributions themselves carry no tax or penalty.
In summary, Roth plans share:
- Non-deductible contributions
- Tax-deferred growth
- Tax-free treatment on qualified withdrawals
- Tax-and penalty-free treatment on early withdrawals of contributions
Differences between Roth IRAs and Roth employer plans
Roth IRAs and Roth employer plans differ in a number of ways. Five such ways are the eligibility requirements to participate, annual contribution limits, plan limitations, Required Minimum Distributions, and the investments available.
- If your income is equal or greater than $122,000 ($193,000 if filing jointly in 2019), the amount you can contribute to a Roth IRA decreases, and if it is equal or greater than $137,000 ($203,000 if filing jointly), you cannot contribute at all. There may be ways to contribute to a Roth IRA even if you exceed the income limits, but this typically depends on factors that include your tax status and the presence or absence of other IRA accounts in your name.
- There are no income limits for Roth employer plans. Eligibility is determined by your employer’s plan documents.
- Annual Contribution Limits
- In 2019, the Roth IRA annual limit is $6,000 with individuals 50 years of age or older being eligible to contribute an additional $1,000 annually.
- Roth employer plan participants can save a much larger amount than they can using a Roth IRA. The 2019 contribution limit for 401(k), 403(b), and 457 accounts is $19,000 with employees 50 years of age or older being eligible to contribute an additional $6,000 for 401(k), 403(b), and most 457 plans. As long as your income doesn’t exceed the Roth IRA limits mentioned above, you may use both a Roth employer plan and a Roth IRA.
- Plan Limitations
- When you withdraw funds from your Roth IRA account prior to age 59 ½ or 5 years of existence, you are allowed to take your contributions out first. For example, if you have a $20,000 Roth IRA with equal parts earnings and contributions, you could withdraw up to $10,000 early before being subjected to taxation and the early withdrawal penalty.
- It may be more difficult or impossible to take an early withdrawal from your Roth employer plan than from your Roth IRA account. Roth employer plans may impose restrictions to access that limit or preclude early, pre-59 ½ withdrawals. Even in plans where early withdrawals are allowed, the IRS treats the distributions differently. From a Roth employer plan, you must take contributions and earnings on a pro-rata basis. Using the above example for the same $10,000 withdrawal, only $5,000 would be treated as a tax-and-penalty free return of contribution and the remaining $5,000 would be subject to the early withdrawal tax and penalty.
- Required Minimum Distributions (RMDs) – RMDs are forced distributions from retirement accounts that begin when individuals reach age 70 ½. These mandatory withdrawals change each year based upon age, whether or not you need the income.
- Roth IRAs are not subject to RMDs and therefore the entire amount continues to grow on a tax-protected basis. If you do not need the income, it can continue to accumulate for the benefit of your heirs or a late life emergency fund.
- Roth employer plans are subject to these withdrawals. While there is no tax on the distribution from a Roth retirement plan, you no longer benefit from the tax-free growth of the amount distributed. It is important to note that, depending on your Roth employer plan, you may be eligible to transfer or rollover the plan into a Roth IRA account that would not be subject to RMDs.
- Investments Available
- Under a Roth IRA, you have considerable freedom in selecting both the company you set up the account with as well as the investments you use within the Roth IRA. This allows you to shop around for what is most important to you, such as a low-fee account with access to thousands of investments, including Exchange Traded Funds or individual stocks.
- Under a Roth employer plan, you may have little to no say over the investment company and are often limited to the investment options selected by the employer.
When looking at your options between a Roth IRA, a Roth employer plan, or both, it will be important to understand your employer’s plan, your income level, your investment objectives, your current savings, and whether any Roth accounts make financial sense as part of your total circumstances. Having a future focused tax and financial plan will help you get the most out of your selected strategy.
Prepared by SVA Financial Group. Copyright 2019.
All information herein has been prepared solely for informational purposes only and opinions are subject to change. Past performance is not indicative of future results and all investments involve the risk of loss of principle. For information on how these general principles apply to your situation, consult an investment professional.