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

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.

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 Then, once contributions are exhausted, earnings are withdrawn.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.

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.

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.