Tax Differences in a Roth 401(k) Vs. a Roth IRA

Roth accounts don't give tax deductions for contributions.

Roth accounts don't give tax deductions for contributions.

Roth qualified retirement plans allow you to save on an after-tax basis: You contribute after-tax income and then take qualified distributions tax-free. To take qualified distributions, you have to be 59 1/2 years old and your Roth account has to have been open for at least five years. However, though Roth IRAs and Roth 401(k) plans both have "Roth" in the name, several significant tax differences apply.

Early Withdrawals from Roth 401(k)s

If you take an early withdrawal from a Roth 401(k) plan, you have to divide your withdrawal between earnings and contributions based on the composition of the account. The contribution portion is tax-free, while the earnings portion is taxable income. For example, if your Roth 401(k) plan is made up of 60 percent contributions and 40 percent earnings, and you take a $10,000 distribution, 60 percent is tax-free and 40 percent is taxable.

Early Withdrawals from Roth IRAs

Like early distributions from a Roth 401(k), early distributions from a Roth IRA are taxable only to the extent that they include earnings. However, with a Roth IRA, you first remove all of your contributions. Then, once contributions are exhausted, earnings are withdrawn. For example, if you have $20,000 of contributions and $10,000 of earnings in your Roth IRA, and you take a $10,000 distribution, the entire amount is a tax-free withdrawal of contributions.

Early Withdrawal Exceptions

Both Roth 401(k) plans and Roth IRAs both offer several exceptions to the early 10 percent additional tax on early withdrawals. However, Roth 401(k)s offer several exceptions that Roth IRAs do not, and vice versa. For example, if you retire after turning 55 years old or take a distribution as a result of a qualified domestic relations order, you can avoid the early withdrawal penalty on a Roth 401(k), but not on a Roth IRA. Alternatively, you can avoid the early-withdrawal penalty on a Roth IRA but not a Roth 401(k) if you take distributions for higher education expenses or a qualifying first-time home purchase.

Minimum Required Distributions

Even though a Roth 401(k) plan offers tax-free distributions, it still requires that you start taking distributions when you turn 70 1/2 years old. With a Roth IRA, you don't have to take required minimum distributions at any age as long as you are the original owner. However, inherited Roth IRAs are subject to required minimum distributions.


About the Author

Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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