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May 3, 2022
Roth IRA vs Designated Roth 401(k)
ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
A recent call with an advisor in Massachusetts represents a common inquiry involving Roth IRAs vs. designated Roth contributions in 401(k) plans. The advisor asked:
“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 | |
| Required minimum distributions | Not during owner’s lifetime | |
| 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 distribution-triggering 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 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 | 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.