CASE OF THE WEEK – Roth IRA vs. Designated Roth 401(k)

By Jenny Kiffmeyer, J.D – The Retirement Learning Center

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 the 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 1/2, 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 1/2, 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.

Pattern

Consider TRA's 3(16) Plan Administration Relief Services (PARS)

To alleviate the day-to-day administrative burdens of yours or your clients retirement plans.
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