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Roth IRAs v. Designated Roth 401(k)s

“What are the differences between Roth IRAs and designated Roth 401(k) accounts?”

Highlights of discussion

While there are many differences, the following chart summarizes some of the key dissimilarities.

Feature Roth IRA Designated Roth 401(k) account
Investment options Generally, unlimited, except for life insurance and certain collectibles As specified by the plan
Eligibility for contribution  Must have earned income under $144,000 if a single tax filer or under $214,000 if married filing a joint tax return ·   Access to a 401(k), 403(b) or governmental 457(b) plan with a designated Roth contribution option and

·   The individual must meet eligibility requirements as specified by the plan

Contribution limit (2022) $6,000 ($7,000 if age 50 or older) $20,500 ($27,000 if age 50 or older)
Conversions Anyone with eligible IRA or employer-plan assets may convert them to a Roth IRA Plan permitting, anyone with eligible plan assets may convert them within the plan to a designated Roth account
Recharacterize contribution Yes, within prescribed period No
Required minimum distributions Not during owner’s lifetime Yes
Tax- and penalty-free qualified distributions, regardless of type of money Taken

·      After owning the Roth IRA for five years and

·      Age 59 ½, death, disability, or for first home purchase

Must have a distributiontriggering event under plan terms, plus

·   Five years after owning the designated Roth account and

·   Age 59 ½, death, or disability

Tax and/or penalty on nonqualified distributions based on type of money According to IRS distribution ordering rules:

1.     Contributions: Always tax- and penalty-free

2.     Taxable Conversions: On a first-in, first-out basis by year; always tax-free; penalty if taken within five years of conversion

3.     Nontaxable conversions:  On a first-in, first-out basis by year; always tax- and penalty-free

4.     Earnings: Taxed as ordinary income, subject to penalty unless exception applies

Withdrawals represent a pro-rata return of contributions and earnings in the account; earnings are taxable and subject to penalty unless an exception applies. See IRS Notice 2010-84 for rules applicable to the return of designated Roth 401(k) converted amounts
Timing of distributions At any time, subject to tax and/or penalty depending on type of assets distributed Following plan-defined, distribution triggering events
Loans No Yes, if plan permits
Five-year holding period for qualified distributions Begins January 1 of the year a contribution or conversion is made to any Roth IRA of the owner ·         Separate for each 401(k) plan in which an individual participates

·         Begins January 1 of the year a contribution or in-plan conversion is made to the account

 Beneficiary Anyone, but spousal consent required in community property states Anyone, but spousal consent required

 

Conclusion

While both Roth IRAs and designated Roth 401(k) plan contributions offer the potential for tax-free withdrawals, there are several key differences between the two arrangements. Whether one, the other or both may be right for a particular investor depends on the individual’s circumstances and goals and should be determined based on a thorough conversation between the investor and his or her tax advisor.

 

 

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